SammyBlueCat

What Is Economic Stimulus?

by Richard W. Rahn a senior fellow at the Cato Institute and chairman of the Institute for Global Economic Growth.

Added to cato.org on December 3, 2008

This article appeared in the Washington Times on December 3, 2008

How much should the U.S. government spend on an economic stimulus program? If you have trouble answering the question, it is because it is the wrong question.

The United States (and the world) economy is (or at least has been for the last few months) in decline with rising unemployment rates. It is widely believed the government must "do something." The political and media classes, and even many economists, call for an "economic stimulus program." But what do they mean by "stimulus," and will it do any good?

The argument is made that many Americans are suffering from a decline in income, and thus the government should give them money so they can buy more and put others back to work. Sounds good - but where does the government get the money? It must either tax someone else now or borrow more money, which diverts productive saving to current consumption. Either way, it is less than a zero-sum game.


Every time direct government payments have been tried, they have failed. During the Great Depression, government spending soared as a percentage of gross domestic product, but full employment did not return until World War II. During the last eight years, U.S. government spending has greatly increased in both absolute terms and as a percentage of GDP, yet the economy now performs worse than it did a decade ago.

When one person is taxed more to pay another person, the incentive to work diminishes and so the total income enjoyed by both people declines. The recipient might be slightly better off for a few months, but the economy (that is, everyone else), and eventually even the original beneficiary will be worse off. The government can only divert savings (through additional government bond sales) for a limited period before everyone will be worse off. The evidence is that the first Bush tax cut back in 2001, which was actually a tax rebate, did little good. In fact, it is now known that people saved much of the money, so the government borrowed some people's savings to provide money for others (or even the same people - who didn't spend it, but saved it). The lesson was learned, and in 2003 the tax rates were cut, which increased incentives for work, saving and investment and hence did a lot of good.

The history of various economic experiments and sound theory (unlike much of the Keynesian claptrap) teaches us government handouts, or tax rebates, are unlikely to do any good and can often be counterproductive.

It is widely believed the government must 'do something.'

Some advocate government spending on infrastructure as part of a stimulus package. In theory, government infrastructure spending (highways, bridges, dams, etc.) can help the economy: if the project meets a solid cost-benefit test; if it is well-managed; if there is little or no corruption; and if it can be done quickly to help the current downturn. Do you want to bet your tax dollars on all of those "ifs"?

If government handouts, tax rebates and infrastructure spending are unlikely to help, what can be done? First, recognize what caused the problem - misguided government monetary policy and financial regulation, which created the wrong incentives, and mismanagement of government-sponsored enterprises (i.e., Fannie Mae and Freddie Mac). Thus, Step One is for those at the Fed, Treasury, Congress, etc. to clean up the financial mess they created.

The government could also cut the payroll tax for both employees and employers for at least two years to allow the economy to get back to full employment. A payroll tax rate cut would have the advantage of immediately increasing home pay for workers, while giving them added work incentives, and giving employers an additional incentive to retain or hire more workers. Critics of the idea will complain it will raid the Social Security trust fund - but since Congress has already spent the trust fund money on other things, the additional liability would mean little.

A payroll tax cut will increase the deficit (and it is more costly than an across-the-board tax rate cut, but it has the political advantage for President-elect Obama that it would not be a further rate cut for the "rich"), but if it puts more people back to work and helps end the recession more quickly, the cost would be justified.

As to the additional hole in the trust fund, the government could shift title to some of the land it holds (roughly one-third of all the land in the United States) to the trust fund.

Politicians complain that companies have been shifting jobs to other countries. A major reason is that corporate income taxes in the United States are higher than other countries and regulations are more severe. So a good "stimulus" for job creation would be to cut the corporate tax rate to make U.S. companies competitive again.

The stock market has plunged, in part, over fear the capital-gains tax rate will be increased. If Mr. Obama would say he will not increase the capital-gains tax and index the basis for inflation, the markets would jump, which would strengthen the balance sheets of many companies. And finally, if the congressional leadership and the president-elect would say they will allow the full writeoff (or at least greatly increase the current $3,500 limit) of capital gains' losses for any new purchase of stock or other productive assets, including real estate, there would be a rush to buy. Current limitations are unfair and economically destructive (the government takes part of the gain, but you take the loss).

The above measures would be less costly and more effective than the various proposed versions of "dumping money out of airplanes," and would provide real "economic stimulus."

Patters

Of course, even the flat tax taxes someone earning, say $1 million, 10x as much as someone earning $100,000, so the flat tax is unfair, too. Are does the author favor a tax rate where everyone, regardless of income, pays say $50,000/year? After all, why should a rich person pay 10x as much as a middle class person for the same government services?

Deficit spending worked well in Depression, though WWII provided the extra deficit spending that fully lifted us out of the Depression. (Why doesn't the author talk about deficit spending during WWII?) It also worked well during the Reagan administration, where we ran up deficits far greater than the tax cuts provided. The economy is fluid, so sometimes its better to cut taxes, while other times it's better to raise them; sometimes it's better to work towards a balanced budget, while other times, deficit spending is better.

Offfering a full write off of capital gains losses is absurd. If would further corrupt the market by encouraging highly speculative investment. There would be a massive increase in scams, and given the fact that the stock market lost around 30% of its value, it would probably result in the US government being unable to meet its obligations.

The idea of a government is to help its citizens. There is more to helping people than merely helping the stock market, something which the author of that piece does not seem to realize.

Real World

The gubmit can spend $1 trillion, and hire a couple of million people, but at some point someone is going to have to pay that trillion dollars, plus interest. Sure, the trillion spent today will have a sooner, rather than later effect on the economy, but what will it's long term ramifications be?

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"The most difficult subjects can be explained to the most slow-witted man if he has not formed any idea of them already; but the simplest thing cannot be made clear to the most intelligent man if he is firmly persuaded that he knows already, without a shadow of doubt, what is laid before him."
Leo Tolstoy, 1897

SammyBlueCat

Disagree. This government was instituted to protect the citizens not to help them. Read article 1 section 8 of the US Constitution.

Patters

This is the preamble, I added the numbers:

"We the people of the United States, in order to form a more perfect union, (1) establish justice, (2) insure domestic tranquility, (3) provide for the common defense, (4) promote the general welfare, and (5) secure the blessings of liberty to ourselves and our posterity, do ordain and establish this Constitution for the United States of America."

Article 1, section 8 merely states the tools at the legislative branch's disposal to achieve the more perfect union.

wistahpatsfan

The preamble is not law.

Patters

The preamble explains the goals of what follows it, so it certainly has legal relevance.

Wildo7

I see a lot more here than simply "protect," and by "protection" I'm guessing you falsely assume only Nation Security:

This is an outline of the powers of the Legislature, not the entire United States Government. And where exactly do you get this limited notion of protection-only from?

Wildo7

It doesn't really matter whether the preamble is relevant to specific law, it specifically describes what the government was formed to do, which goes beyond "protection." To claim that the government was set up only to protect and not help it's citizens when the introduction of the founding document specifically states otherwise is fallacious.

Real World

I don't see creating a welfare state in anything, anyone posted. Where's it say welfare state inside the Constitution?

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"The most difficult subjects can be explained to the most slow-witted man if he has not formed any idea of them already; but the simplest thing cannot be made clear to the most intelligent man if he is firmly persuaded that he knows already, without a shadow of doubt, what is laid before him."
Leo Tolstoy, 1897