Home > Market Commentary > Don’t Just Do Something — Stand There! Why the Stimulus Package Won’t Work

Don’t Just Do Something — Stand There! Why the Stimulus Package Won’t Work

by David Sollars.

It appears that the U.S. Congress is set to pass a $850 billion dollar spending package designed to provide fiscal stimulus for the U.S. economy.  It is a mix of spending increases, transfers and tax cuts purportedly designed to pump up aggregate demand.  Both tax cuts and spending increases create budget deficits, and therefore the government must increase borrowing to finance its operations.  Add in the interest charges and this legislation easily surpasses a trillion dollars in total cost.

They idea of fiscal policy stimulus goes back to the Great Depression and the work of John Maynard Keynes.  The basic  idea is pretty simple — in times of weak aggregate demand, government could fill the void by spending more directly, or taxing less, thereby increasing consumer demand and business investment.  All policymakers would need to do is measure the needed stimulus (taking into account the multiplier effect, and then properly time the injection of stimulus in the economy. If the economy got overheated and inflation became a problem, then presto, the federal government could raise taxes or reduce spending to slow down the economy.

In theory, traveling to the moon is easy as well.  All you need was the right vehicle, pointed in the right direction, traveling at the right speed, etc.  But in practice, manned space flight turned out to be a little more complicated and costly. Unfortunately, economic theory and policy tools have not advanced to the point that we should have any confidence in the ability of this short run program to work as advertised. There are timing problems, scale issues and efficiency costs associated with discretionary fiscal policy that are well known (and discussed in any Econ Principles textbook) and will reduce the potential benefits and create unintended consequences. But the political need to do something will win the day, and Washington is all a-twitter with the single largest discretionary budget package ever devised.

Good politics is often bad economics.  Even a cursory look at the bill being rushed through the Congress reveals its Frankenstein-type nature.   It is a wish list for unrelated spending programs that, on their own, would not be considered reasonable.  Even the parts that make some sense, like the much-touted infrastructure spending, are small potatoes in the bill.  Instead we get millions for the National Endowment for the Arts.  The Department of Education gets $66 billion for  . . . well, we aren’t sure, but how can you oppose to education?  Amtrak gets a billion so that it can continue to lose money each year.  Congress even provides more millions to help those poor souls who will flounder from a lack of analog television transmission.  Some of the items are laughable – Speaker of the House Pelosi defending contraception subsidies as stimulus on the weekend new shows was a sure sign of some of the insanity behind this bill. Even traditional liberals can’t stand the stench.  Former CBO head and Clinton budget guru Alice Rivlin suggests separating the defendable stimulus pieces from the pork and the other things that have magically appeared without the usual substantive review.  According to some analysts only 5 to 10 percent of the total bill is actually related to stimulus spending.  Even worse, the “buy-American” requirements will likely result in WTO sanctions and encourage retaliation by our trading partners, hurting U.S. companies and workers in the export market – one of the few remaining shining lights in our current economy.  Just ask Caterpillar.

The little hard analysis that has been done reveals another serious flaw in the bill.  Much of the actual stimulative spending won’t occur this year, or the next year.  The recent CBO report suggest that most of the new spending that is part of the omnibus-bill won’t kick in until next year and the year after, long after our best estimates on when the  trough is reached  http://www.cbo.gov/ftpdocs/99xx/doc9968/hr1.pdf.  The levers of government  are slow and unwieldy even for someone as brilliant as Larry Summers!  Even Keynes later thought that public works and infrastructure projects were poor vehicles for short run stimulus given the realities of actual government expenditure — it takes time to build roads and bridges. 

My proposed solution: Take a deep breath and let’s consider what useful things might be in the bill.  The less controversial things like temporary transfers to the states to extend unemployment benefits, foodstamps or Medicaid make some sense in the interest of helping those who have lost their jobs in the recession.  But these aren’t job creators; they are more in the spirit of what we used to call public assistance.  Speeding up some public infrastructure spending might be useful, but it is limited.  If you really want to spur investment then include investment tax credits.  If you want to help working consumers, then halve the payroll tax for the next year.  Let the results show up in the end of February paychecks, and let actual taxpayers choose how to spend it.  The Senate version of the bill has the AMT fix for 2009, which is a good thing—but why don’t we just fix AMT now and forever instead of relying on one year fixes?  Any pretense of fiscal discipline is now officially shattered, so get on with it already.

Will any of this really work to stimulate the economy?  Probably not.  But it will impose fewer costs and not drive up the deficit as much as the current bill, which won’t work either.  We seem to forget we tried the lump-sum tax rebate trick last year. The emergency TARP bill that was passed year is starting to reveal its immense shortcomings.  Why do we expect this outcome to be different?  If we are going to go into debt for a trillion dollars, could we require some standard ROI analysis to demonstrate how this spending is going to stimulate the economy? At least that might actually create jobs for the thousands of financial analysts laid off in New York and around the country.

David Sollars is Dean of the Business School at Washburn University in Topeka, Kansas. You can reach him via email at david.sollars@washburn.edu.

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