In the Nation's Interest
The Stimulus Conundrum
All Three Sides in Today's Stimulus Debate Are Off-Base
The nation's most urgent priority right now, an economic stimulus package, is foundering. We have a three-sided - call them Left, Right, and Center - debate. Each side has some element of the correct (as judged by the current writer) view of the issue, but each side is mostly off-target. Time is short, and the problem is serious. Let's look at the major nubs of the debate.
Ditch the rhetoric. It's not "recovery," it's "stimulus." The economy is in a frightening slide. Sound action is needed urgently. However, the debate has been sidetracked by a desire "not to let a crisis go to waste." Unfortunately, high-priority bills are seen as "trains" in Washington, to which every interest wants to couple its own car. Some - mostly from the Left, but also from the Right - see the stimulus bill as an opportunity to cut a quick deal on what they cannot sell with full deliberation and scrutiny. (For those on the Left, the extra cars are spending; but those on the Right are equally motivated by a desire for tax cuts with less-than-consensus public support.)
There are two results. First, there is delay; then, the eventual package is less effective than it needs to be. In the end, the crisis will not go to waste; but it will not be solved, either.
The delay arises because the package becomes bigger and more complex; and the added provisions, despite their advocates' desire for a low profile, inevitably attract scrutiny, raise controversy, and extend the debate.
As just one example: Advocates of infrastructure spending to revive the economy must, to have any credibility when challenged, claim that such spending is "ready to go." If there are projects that are "ready to go," there must be a list of such projects. Take that list, choose the half-dozen projects that are least politically attractive and defensible, and those projects will become the public face of the entire legislative effort. They will be reviled, and the merit of the entire initiative will be called into question: If the bill includes these clunkers, how can we, the public, believe that anything in it is well chosen? Anyone who watched the abortive 1993 Clinton stimulus effort with one eye open would have been able to see that the current bill, given how it materialized, would fall into the same trap.
The ineffectiveness of the package follows from the policy choices involved. The emphasis on infrastructure is a prime example. The public infrastructure industry has only so much capacity. The greatest part of public infrastructure spending is highway construction and repair. The federal government's contribution to highway spending, through grants to the states, was less than $40 billion in fiscal year 2008. All federal outlays for physical capital - including grants and direct expenditures for water, sewer, housing, education, and all other purposes in a normal, non-stimulus year - was little more than $100 billion. The proposed infrastructure spending (Energy and Water, Interior and Environment, and Transportation) increase in the House stimulus bill is about $120 billion. Some of this funding would fill in for state and local government cutbacks, to be sure. But the only way that the infrastructure industry could absorb such a spending increase would be to invest enormously to scale up its own capital base, which would take years, and then to spend out the increase in funding over a long period of time. That would involve, in the first instance, substantial delay while the economy stalls. (The Congressional Budget Office estimates that less than one-third of the House bill's transportation spending would outlay by the end of 2010.) It also would be pointless and wasteful unless the federal government was prepared to commit to a substantial long-term increase in spending on infrastructure to use that new industry investment - at just the time when federal deficits and debt are projected to balloon unsustainably.
We may believe that a substantial increase in infrastructure spending is necessary; but executing such an increase in the haste made necessary by the current economic emergency surely would be inefficient and wasteful. A sound stimulus bill would provide aid to state and local governments (see below) that would save them from postponing or cancelling infrastructure spending projects; in other words, the federal stimulus program should keep the infrastructure industry fully employed. However, building up the industry's book of business years in advance is not stimulus, and risks serious waste in the choice of projects and accumulating unnecessary capacity.
And for another example: Both the House and Senate bills include many new, and arguably meritorious, programs - for education, the environment, energy, and many other priorities. However, by definition, a new program, however meritorious, will not move quickly. New procedures must be created, rules must be written, government personnel must be assigned, proposals must be issued, responding applications must be reviewed, contractors must be evaluated, and so on. Furthermore, virtually any new program can benefit from some additional careful thought. The Congressional majorities will not go away. These new programs can be passed a few months after the stimulus program, with better planning and therefore better results. Why open the more-urgent stimulus package to valid criticism to pursue these initiatives in haste?
As a defense against these (in my opinion) valid arguments, advocates of the current bill have taken to language control, referring to it as a "recovery" plan, not a "stimulus" plan. But this is an urgent problem that will not respond to rhetoric, however well-meaning. We have a dangerous economic slowdown. We must address it with all feasible speed. What we need is a stimulus bill, not a "recovery plan." Investment initiatives that follow the stimulus program by months, in an economy that has found its feet, will be more effective than somewhat inferior versions that must try to take root in a stagnant economy.
So ditch the rhetoric, and face up to the seriousness of the problem.
All spending - provided it actually happens - is "stimulus." Another inaccurate view comes from what might be called the Right. This view holds that grants to state and local governments, if they merely allow those governments to maintain their levels of spending rather than cutting them (or imposing tax increases), are not stimulative and do not create jobs.
The reality is that any spending - provided that it really happens - does stimulate the economy, and does create jobs. By any reasonable view, that includes forestalling spending cuts - by state and local governments or anyone else - that would have taken place without federal assistance.
The view that heading off state and local government tax increases is not stimulative is particularly hard to swallow. If the same persons making this argument were asked if they favored a federal tax increase in this economy, they would blanch. Contemplating a rash of state and local tax increases should be just as alarming, and preventing those tax increases therefore should be a very high priority.
Just as in the narrower issue of infrastructure (much of which is undertaken by state and local governments), grants to governments must be handled correctly if they are to work. Overdoing it doesn't help; piles of cash that would sit unused for a year are not stimulative now. Grants that are heavily earmarked will put those governments into procedural straitjackets that will slow the process unacceptably. Instead, an important component of a federal stimulus program should be to fill a significant part of the recession-induced revenue gap in state and local finances with unrestricted funds, which should allow those governments to avoid layoffs, maintain their infrastructure investment programs, and forestall counterproductive tax increases. It also would allow policies to extend unemployment compensation, health-care benefits and food stamps to those who have lost out in the current stagnant job market. Relieving the human pain of this downturn is very much a valid goal of government.
Some would argue that unrestricted grants for states and localities would be wasted because they would not pursue federally chosen priorities; but that argument misses the key point. If state and local governments have funds without strings, they will use those funds for the purposes that they deem most important. If confronted with heavily restricted funding for programs that they do not want, those governments will do everything they can to shift those funds toward what they want to do anyway. Strong earmarking will yield limited rewards and waste time in state and local government red tape. Taking more time to configure any new programs to work more effectively will increase the chances of state and local cooperation, and therefore of ultimate success.
Size the solution to the problem. Yet another unproductive argument in this debate comes most prominently from the Center, some of whom see reducing the size of the stimulus package as fiscally responsible. This view runs afoul of the basic physics of this issue.
The problem in the economy is that total spending (by consumers, businesses, and governments) is running far shy of the economy's capacity to produce. That means that workers and factories are sitting idle, exacting a painful human cost and wasting those resources. If consumers lack the income and the confidence to spend, then businesses have no reason to build new factories and machines (that is, to invest). The only way to snap the economy out of this swoon is to have government spend (or induce others to spend) to fill in this gap.
Economists can and will argue about the precise estimates, but this gap does have a numerical size; the Congressional Budget Office estimates it at almost eight percent of the potential GDP - a massive number, almost $1.2 trillion. Government will not want to fill the entire gap at once, because the first-round spending will induce further spending in a multiplier process, and it would be harmful to overshoot. However, the downside risk today is so troubling that most economists are more concerned about doing too little than too much.
And therein lies the physical rule: Once the appropriate size of the stimulus is determined, cutting back in the name of fiscal responsibility is actually destructive rather than constructive. It would be akin to deciding to save leather by buying a size six shoe for your size ten foot; once it becomes clear that the too-small shoe will not do the job, it will take still more leather to build proper footgear. Similarly, if a too-small stimulus leaves the economy in the doldrums, going back later to add more stimulus will simply increase the cost - that on top of the human cost of people and businesses left sitting idle, without incomes and without hope.
The Center now advocates removing items from the stimulus bills in the Congressional debate. To the extent that those items are ineffective or otherwise ill-chosen, this is in part to the good. But assuming that the current bills of roughly $800 billion are either too small or at best of the correct size - and many economists would argue that they are, if anything, too small - policymakers should replace those items with effective stimulus to re-fill the economic spending gap.
Tax cuts can be effective stimulus, but the wrong tax cuts now would be dangerous policy. In one final respect, all sides of the current debate agree in the large, while disagreeing in detail. And yet, all sides are also wrong. Tax cuts can be effective at stimulating the economy, and every current voice in the debate calls for tax cuts; but at least in my opinion, everyone now is calling for the wrong tax cuts.
The popular press suggests rather glibly that no one is worried about the federal budget deficit right now. The reality is that our holiday from worries about the deficit will be short. Even before the economic implosion last fall, the budget deficit already was a serious long-term problem. The deficit is a problem because it adds to the nation's debt, which is growing far too fast - faster than the nation's income (that is, the gross domestic product, or GDP) out of which the interest on the debt must be paid. The interest cost could grow so large as to become a painful, or even an impossible burden on the taxpayers; furthermore, the Treasury's borrowing could become so large as to frighten both the domestic and the international capital markets. The large deficits that result directly from the current recession, plus the necessary bailout of the nation's financial institutions, and the essential stimulus program all will add up to make this already serious problem even worse.
In this environment, every political side on this issue, Left, Right, and Center, proposes or accepts permanent tax cuts. The Left won the White House on proposals for permanent tax cuts aimed at middle-income taxpayers; the current stimulus legislation would put those tax cuts into effect for only two years, but with the clear subtext of keeping the campaign promise on a permanent basis. The Right wants permanent tax cuts aimed much more toward upper-income persons and business. The Center accepts the permanent tax cuts already in the proposals.
This near-consensus is dangerous. The nation simply cannot afford permanent tax cuts at this time. Permanent tax cuts, once enacted, will be impossible politically to remove. The lost revenue will require even more budget tightening to head off the nation's spiraling debt.
Still, tax cuts will be essential for a successful stimulus. There simply is not enough spending capacity in the federal, state, and local governments combined to deliver the timely stimulus that is needed to stop this economic downturn. Keeping state and local governments funded, including uninterrupted infrastructure investment to the full capacity of the construction industry, will provide only a part of the economic boost that is needed. Opportunities for quick federal spending are likewise limited. The rest of the necessary stimulus must be provided through consumer spending, fueled by tax cuts.
And the way to provide that economic boost, with the least damage to the budget, is through temporary individual income tax rebates. Rebates can be distributed quickly, as was demonstrated by the rapid distribution of the most recent round of payments last year. Right now, rebates could be tied to the individual income tax returns that are just being filed for incomes from 2008. The mechanisms to deliver the rebates already exist, and the legislation is simple; using rebates would not slow the enactment of a stimulus package. The full amount of a rebate can be delivered up front, making it much faster than a permanent tax cut that may be spread in small doses over paychecks stretching out into the future. Rebates can be aimed directly and predominantly at persons with modest incomes, who are most likely to need the money and to spend it quickly. And they can be explicitly temporary, distributed outside of the structure of the income tax, and so unlikely to be built into the expectations of recipients as potentially permanent.
Still, there has been criticism of income tax rebates. Some economists have argued that the income tax rebate last year did not prevent the current economic downturn, and thus was demonstrably a failure. That is an unfair judgment. The problems of the economy were extraordinarily severe. Many macroeconomic forecasters were surprised that the economy did not turn down much sooner, and attributed its resilience to the effect of the income tax rebates. In other words, without the rebates, things would have been much worse.
Some economic critics of the rebates have argued that they were saved, rather than spent, and therefore in fact provided little stimulus. Again, that criticism is unfair. The rebates likely spent some time in the recipients' bank accounts, and thus were perceived as increased saving. However, again, macro forecasters concluded that the money was spent over the next calendar quarters, relative to reasonable expectations of what spending otherwise would have been, and that this spending helped to delay the current downturn. Additional tax rebates now likewise would be spent - not instantaneously, but in realistic short order, because people now are hurting badly. That spending would help to add upward momentum to an economy that is in serious need of a lift.
Income tax rebates could be scaled to the necessary size of the stimulus much better than any realistic assistance to infrastructure and the like through state and local governments. Rebates could be targeted to households with modest incomes, extending up the income scale in perhaps gradually decreasing amounts to as many households as necessary to achieve and maintain political consensus. A quick and substantial stimulus of this nature is what the economy needs at this time, with the threat of truly serious recession looming.
For those from the Left and Right who argue that a bigger portion of permanent tax cuts than temporary rebates would be spent, there is a quick and easy answer: Make the rebates bigger. On a cost-effectiveness standard, there is no comparison. Do the most simple-minded math: Make the rebates twice as large as the annual amount of a permanent tax cut, and after two years, the budget breaks even. In future years, the budget is way ahead with the temporary rebates. Make the rebates even larger if necessary to get consumer spending going, and the budget still will be better off in the long run.
Conclusion. Our economic problem is more serious than any in the living memory of virtually any American. We need to act quickly, but that really means that we need to increase purchasing power quickly. All parties in this debate are invested in their own positions and points of view, so retreat would be painful. But the stakes are too high to allow politics to stand in the way. The approach suggested here is far simpler, far more straightforward, far quicker, and far more effective for this urgent problem than anything else on the table. It is not too much to ask for our elected leaders to put the country first.
Commentaries are the views of the authors and do not necessarily represent policies of the Committee for Economic Development.