Study: Congress’s budget battles have cost the economy $700 billion so far

October 16, 2013

Here's an eye-catching claim: A new report from Macroeconomic Advisers argues that Congress's budget battles, debt-ceiling stand-offs, and spending cuts have cost the U.S. economy nearly 3 percent of GDP since 2010.

That's roughly $700 billion in lost economic activity and more than two million lost jobs— all thanks to Congress. And that's before we even factor in the losses caused by the recent federal government shutdown.

But is this true? Are lawmakers really doing that much damage to the U.S. economy? A claim like this needs unpacking, as there's ample reason for skepticism. So let's break this report down piece by piece. There are two big arguments here:

1) Spending cuts have taken a bite out of economic growth. First, the report estimates that spending cuts enacted by Congress since 2010 have shaved 0.7 percentage points off annual U.S. economic growth over the past three years:


In the chart above, the dashed red line is an estimate of what U.S. growth would have been if discretionary spending had stayed constant as a share of GDP since 2010.

But spending didn't stay constant. Various stimulus programs began winding down. And then, in August of 2011, Congress enacted the Budget Control Act, which set hard caps on discretionary spending and set things in motion for the sequestration budget cuts of 2012. All told, discretionary spending shrunk from 9.4 percent of GDP in 2010 to 7.3 percent today.

The report argues that this sort of fiscal drag is harmful when the U.S. economy is still far below full employment. As a result, the spending slowdown cut annual GDP growth by 0.7 percentage points and cost "the equivalent of 1.2 million lost jobs."

(Remember, that's a drop in yearly GDP growth, so the losses compound over time.)

2) Increased "policy uncertainty" due to congressional showdowns has also hurt growth. But the report isn't done yet. They also estimate that all the turmoil and uncertainty due to Congress's fights over the debt ceiling and the "fiscal cliff" has put a smaller dent in growth. Here's their second chart:


The report uses the Economic Policy Uncertainty Index constructed by Stanford and University of Chicago economists and argue that it correlates with slower growth:

Although uncertainty might directly discourage households from spending and businesses from hiring and investing, we’ve found little evidence of such a direct link.

Fiscal policy uncertainty is, however, inversely correlated with stock prices and positively correlated with private 'credit spreads.' Hence, by undermining wealth and raising private borrowing costs, fiscal policy uncertainty can indirectly undermine household spending as well as business hiring and investment.

Their implication is that growth would be higher without all this brinkmanship. The increased policy uncertainty, the report argues, "lowered GDP growth by 0.3 percentage points per year, and raised the unemployment rate in 2013 by 0.6 percentage points, equivalent to 900,000 lost jobs."

When you add these two effects up — and account for compounding growth, as Paul Krugman does — then the report essentially implies that Congress's budget battles have cost the United States roughly 3 percent of GDP, or around $700 billion of wasted economic potential and more than 2 million lost jobs since 2011.

Potential criticisms of these numbers

There are a few questions worth raising about the Macroeconomic Advisers report. For one, the report assumes that the Federal Reserve hasn't been able to offset most of the economic pain from Congress's "fiscal drag."

But is that really true? The central bank has taken a number of steps this year to boost the economy — including another round of quantitative easing. If the Fed's moves had a bigger effect than people think, then it will turn out that Congress's spending cuts may have done less damage than Macroeconomic Advisers is estimating.

Similarly, some experts have criticized the idea that "policy uncertainty" is really hurting growth. For one, the uncertainty index stabilized dramatically in August 2013, but the U.S. economy didn't surge as a result.

What's more, as Mike Konczal has pointed out, those touting the index may be reversing the causality here — there's reason to think that poor growth causes policy uncertainty, rather than the other way around. (The Macroeconomics Advisers report does, however, try to account for this effect by modifying the index: "We also removed a cyclical component from the index," they write, "because recessions foster debates about possible fiscal responses, the uncertainty over which is the result of a weak economy, not the cause of it.”)

In any case, it's entirely plausible that Congress has throttled the U.S. recovery, either by cutting back on spending prematurely or increasing the amount of uncertainty in the economy — or both! But a solid estimate of the impacts here is often hard to come by, and a lot depends on the assumptions used in these economic models.

Note: The numbers above don't include the cost of the shutdown, which S&P recently estimated sapped another $24 billion from the economy this quarter (although other economists have suggested that some of that activity may get made up once the government reopens).

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