By Robert J. Barro, Veronique de Rugy
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While the potential impact of across-the-board federal defense spending cuts on national security may be up for debate, a new study published by the Mercatus Center at George Mason University finds predictions of these cuts’ dire impact on the economy and jobs grossly overblown.
In “Defense Spending and the Economy,” Harvard University professor of economics Robert Barro and Mercatus Center senior research fellow Veronique de Rugy survey existing research on the “multiplier effect” of an extra dollar of government spending on GDP to examine the economic impact of changes in federal defense spending.
The examined studies show that a dollar increase in federal defense spending results in a less-than-a-dollar increase in GDP when the spending increase is deficit financed. Combining this with a tax multiplier that is negative and greater than one, the authors estimate that over five years each $1 in federal defense-spending cuts will increase private spending by roughly $1.30.
Below is a brief overview of the study’s conclusion.
Aggregate Effects from Cutbacks in Defense Spending
Treating sequestration as a cut of 5 percent in defense outlays, defense spending would fall $34 billion in 2013 from its 2012 level of $677 billion. For given taxes and other federal spending, the defense-spending cut reduces the federal deficit. Hence, the public debt is lower than it would be otherwise, and requires correspondingly lower taxes in the long run compared to a benchmark path (if other federal spending does not change).
Using a defense spending multiplier of 0.4 within a year and 0.6 over two years and assuming that taxes have a multiplier effect on GDP of -1.1 with a one-year lag (consistent with the multiplier literature), real GDP falls compared to the benchmark path by $13.6 billion in 2013 (because of the spending multiplier) but rises by $17 billion in 2014 (because the effect from the tax multiplier more than offsets the spending effect).
Private-sector portions of GDP rise by $20.4 billion in 2013 (60 cents on the dollar compared to the spending cut) and $51 billion in 2014 (because GDP is now above its benchmark).
The effect of +$17 billion on real GDP continues into the future.
Relative to the benchmark path, defense spending falls by $170 billion, taxes are cut also by $170 billion, private sector portions of GDP rise by $224 billion and real GDP increases by $54 billion by 2017.
In other words, over five years, we get roughly $1.30 of extra private spending for each $1.00 reduction in defense spending.