The Stimulus Package – Weekend Thoughts

Now that the stimulus package has taken shape, and the Senate has acted on it, we can give a better assessment of its likely impact. My first reaction is huge disappointment. The debate that we all followed last week ended with a small group of Senators, the so-called ‘centrists’, cutting away some of the spending in the original package. The effect was to lower the amount of stimulus the economy will get, and to alter the thrust of the program. As the package now stands it is more focused on tax cuts than it should be, and is much smaller than it needs to be. These are both significant failings.

The urge to avoid a Republican led filibuster led the Obama administration into some very poor decisions. The price paid to secure those three GOP senator votes – enough to get the total vote filibuster proof – was immense. The resultant package is weak and could well be ineffective. Instead of standing firm and precipitating a fight in the Senate where the public could have seen the two sides arguments more clearly, the Democratic leadership gave way. This is not a good start to dealing with our crisis.

Some of the programs cut would have had immediate and easily understood impact: getting aid to states having fiscal difficulties so that they could maintain their own programs rather than cut them is an obvious example. Instead the ‘centrists’ wanted that aid eliminated. I am not sure why. The visceral ideological objection that the Republicans have to Federal involvement in local matters seems to be the most likely reason, but the damage this stance will have is very high, and will surely make the recession deeper than need be.

Allow me to explain:

America has not one but many government budgets. From a budgetary perspective it truly is fifty countries acting together as if they were on. Some of those state budgets are huge: California for instance qualifies as the 13th largest economy in the world were it an independent country. New York is similarly huge. So when we assess fiscal policy and its impact on the economy we have to aggregate all these budgets and not just focus on the Federal level. Under normal circumstances, of course, the Federal budget dwarfs the state budgets even when they are all added up. Also many states have been subject to restrictive populist efforts to limit spending and the amount to which they can run deficits. There has been a surge of interest in the past two decades in establishing fiscal constraints at the state level. So when a recession bites and local tax revenues fall many states are forced into budget cutting in order to meet their statutory obligations. Unfortunately this is exactly counter to sound economic practice. It is in times of recession that we need governments to spend money, even if it means running deficits. The whole argument about the Federal stimulus package is founded on this economic principle. Now the problem of cutting aid to states becomes obvious: is states are forced by local action to cut spending they are inevitably making the national situation worse. Unemployment will rise and the country as a whole will suffer. Not only this but at least part of the national stimulus effort is offset or neutralized by the states cutbacks. The original stimulus package recognized, hence the inclusion of aid to the worst affected states. In fact it is quite reasonable to argue that aid to states should have been much larger and more broad.

While I understand [but don’t agree with] the partisan logic behind trying to undermine the package, stripping out local aid is stretching the ideological argument to its limit. Not only do we water down the package, but we make it more difficult to succeed because the states will be left to flail and thus cutback. By all means cut some of the more daft Democratic inclusions, but this is plain stupidity. Why would you do something this silly and then turn around and vote for the package you have just tried to neuter? It would have been better just to vote no all along.

If this is an example of the intelligence and economic savoir faire of the ‘centrists’, and if we going to have to rely on them to help get the legislation necessary to help the economy passed, then we are deep trouble.

And that’s just one reason not to like what the Senate did.

A second is their obsession with tax cuts. By now pretty much every respectable economist, on both sides of the political divide, have come out and said that tax cuts won’t help us much, if at all. But ideology dies hard. So almost a third of the total package consists of ineffective proposals that we can all agree in advance won’t work. This tax cutting nonsense has to stop. While we all love to get money back from the government we need to recognize that the tax cut is being paid for by issuing debt. It is thus an illusion since we have essentially borrowed from the future to make ourselves feel good now. Since history shows that a large chunk of the tax cuts will end up as savings, either through debt pay downs or through hoarding, it makes little sense to borrow to that end. Stimulus means spending. And unfortunately, if you are a right winger, that means government programs like bridge building or railroad construction. Most of our major dams, the Interstate road network and the Internet resulted from government programs and they all have enduring economic benefit to us all. Government spending is thus not waste. Tax cuts can evaporate into savings accounts and thus leave little record and have little impact. It may seem complicated and even counter intuitive, but the evidence is now convincing. So to force a higher concentration of tax cuts into the overall program is counter productive, costly, and daft.

The third objection is much more simple. They reduced the package. It wasn’t big enough to start with and needed to be much larger, not smaller. This was a timid effort all around and will certainly lead to a much weaker recovery than we could have arranged for ourselves. The shortfall in projected GDP from its potential is now estimated to be around 14% over the next two years. To close that gap the stimulus should have been over $1 trillion. The consequence of this timidity is not small: it probably means over half a million fewer jobs will be saved than had we been sensible and bold.

So just when we needed strong, we got weak. That’s not a good start to solving the crisis. And it’s not a good omen for the future. We must, to paraphrase my old teachers, “try harder”, because our current grade is a very weak C-.