Case Against Fiscal Stimulus

8/8/2019 Case Against Fiscal Stimulus

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THECASEAGAINSTTHEFISCALSTIMULUSJEFFREYMIRON*

INTRODUCTION

When President BarackObama took office onJanuary 20,2009, theU.S.economyhadbeen in recession foroverayear,and the prospects for a quick recovery appearedbleak. TheFederal Reserve had already lowered interest rates to zero,which implied thatmonetary policywas unlikely to providefurther

stimulus.1

Thus,

the

Administration,

along

with

many

economistsandpundits,turnedtotheotherkeypillarofstabilizationpolicy:fiscalstimulus.Thefiscalapproachwasimmediatelycontroversial,however,

fortwomainreasons.First,academiceconomistshavecometoregard fiscal policy as less suitable thanmonetary policy forstabilizationpurposes,principallybecausemonetarypolicycanactquickly,whereas fiscalpolicycan suffer significantdelaysinadoption,implementation,andimpact.2Second,theU.S.wasalready facing a dismal longterm fiscal outlook because ofprogramslikeMedicare,Medicaid,SocialSecurity,thewarsinIraq and Afghanistan, and the TARP bailout. This outlookmade

some

economists

wary

of

new

measures

that

would

in

creasethedeficit,evenifonlytemporarily.YettheAdministrationapparentlyconcluded that ithadnoalternativegiven thestateoftheeconomy,soitplowedaheadwithafiscalstimulus.Decidingtoadoptafiscalstimulus,however,didnotresolveall

oftheissues.Theotherquestionwaswhatcombinationoftaxcutsand expenditure increases to include in the stimulus package.StrictKeynesian theory holds that any tax cut or spending in

*DepartmentofEconomics,HarvardUniversity.1.TheConscienceofaLiberal,http://krugman.blogs.nytimes.com/ (Jan.19,

2009,

07:58

EST).

2.Martin Feldstein, Rethinking the Role of FiscalPolicy, 99AM.ECON.REV.556,556(2009).


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520 HarvardJournalofLaw&PublicPolicy [Vol.33

creasecanstimulatetheeconomy,evenifthetaxcutisbadlydesignedandeveniftheincreasedspendingisforworthlessjunk.3Ifthisperspectiveisright,quibblingabouttheexactcompositionof

thepackage

is

neither

necessary

nor

fruitful.

Iarguehere,however,thatthestructureofafiscalstimulusiscrucially importantand that thepackageCongressadoptedwas far from ideal, regardless of themeritsof theKeynesianmodel.Whether countercyclical fiscalpolicy isbeneficial is amoredifficultquestion,butitisnotthecriticalissueifastimuluspackage isproperlydesigned. In fact, theAdministrationcouldhavecreatedapackage that stimulated theeconomy inthe short termwhile improving economicperformance in thelongterm.Thispackage,moreover,wouldhavebeenimmuneto criticism from Republicans. The stimulus adopted was amissedopportunityofcolossalproportions.

Thatthe

Administration

and

Congress

chose

the

particular

stimulus adopted suggests that stimulating the economywasnot their only objective. Instead, theAdministration used therecession and the financial crisis to redistribute resources to favoredinterestgroups(unions,thegreenlobby,andpubliceducation)andtoincreasethesizeandscopeofgovernment.4Thisredistribution does not make every element of the packageindefensible,buteventhecomponentswithaplausiblejustificationweredesigned in the leastproductiveandmost redistributionistwaypossible.TheremainderofthisEssayisorganizedasfollows.PartIdis

cusses thearguments forandagainst fiscalstimulus.Parts IIIV

examinethe

main

components

of

the

stimulus

(tax

cuts,

energy

programs,and infrastructurespending,respectively).PartVaddresses othermiscellaneous components. PartVI considers thebroaderimplicationsofthefiscalstimulus.

I. THEKEYNESIANMODELThe standardjustification for a fiscal stimulus relies on the

Keynesianmodeloftheeconomy.Thismodelhasbeentaughtto

3.For a standard presentation of the Keynesian model, see N. GREGORYMANKIW,PRINCIPLESOFECONOMICS737826(5thed.2008).

4.See

WSJ.com,

Getting

to

$787

Billion,

http://online.wsj.com/public/resources/

documents/STIMULUS_FINAL_0217.html(lastvisitedJan.27,2009)(listingmorespendingontheenvironmentthanontaxcuts).


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No.2] CaseAgainsttheFiscalStimulus 521

generationsofcollegestudentsineconomicsclassesaroundtheworld,andeconomistswidelythoughnotuniversallyacceptitasthestartingpointforanalyzingboomsandrecessions.5

Accordingto

the

Keynesian

model,

recessions

occur

because

ofalackofaggregatedemand,andgovernmentcanremedythisshortfallbystimulatingdemand.Ontheonehand,governmentcanincreaseitsowndemandforgoodsandservices,forexamplebybuildingmorehighways,purchasingmoremilitaryaircraft,orfundingadditionalresearchanddevelopment.6Ontheotherhand, government can increase demand from consumers andfirmsbyreducingtaxesorincreasingtransfers.7Although theKeynesianmodel of fiscal stimulus iswidely

accepted, it remains controversial as ajustification for policyinterventions.ThefirstdifficultywithKeynesianfiscalstimulusisthatthelagbetweenrecognitionthataninterventionmightbe

necessaryand

the

impact

of

that

intervention

is

likely

to

be

long

and variable, so policy can easily endup stimulatingwhen itshouldbecontracting,orviceversa.8Thus,thepracticeofcountercyclicalpolicyislikelydifficultevenifthetheoryisunassailable.Overthepastseveraldecades,mosteconomistshavetherefore gradually emphasized monetary policy as the moreappropriate tool for countercyclical policy. Lags in monetarypolicyalthoughstill relevanttend tobeshorteronaverage.9Thecurrentrecession,forexample,beganinDecember2007,yetthe fiscal stimuluswas not adopted until February 2009, andmuchoftheplannedspendingwilloccurin2010.10Thesecondissueisthat,althoughKeynesiantheorysaysthat

thechoice

of

spending

projects

does

not

matter,

spending

on

projectsthatmeetstandardcostbenefitcriteriamakesthemostsense and ensures thebest use of taxpayer resources in theshort term. Further, temporary programs may become longtermorpermanentgiventhepoliticaldifficultiesofeliminatinggovernmentprograms.

5.SeeMANKIW,supranote3,at737826.

6.Seeid.at78788.7.Seeid.at79293.8.Seeid.at83031.9.Feldstein,supranote2,at556.

10.Brian

Wingfield

&

Joshua

Zumbrun,

Stimulus?

Yes,

in

2010,

FORBES.COM,Jan.

28,2009,http://www.forbes.com/2009/01/28/economy stimulusunemploymentcongressbusinesswashington_0128_stimulus.html.


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Even ifsignificantnumbersofproductiveprojectsexist,usingthemtostimulate theeconomy isdifficult. Identifying therightprojects,planning them appropriately, andundertaking

themat

asensible

pace

can

take

years,

not

months

or

weeks.

Thus, thedesire forgoodprojects conflictswith thedesire toundertakenewspendingquickly.Beyond theseproblems, the standardKeynesiandefenseof

fiscal stimulus fails to recognize that attempts to stimulatemightexacerbaterecessionsorhavenegative longterm implications,eveniftheKeynesianmodelisessentiallycorrect.Thelower taxes and higher spending requiredby the Keynesianapproachmean increasedtaxesatsomefuturedate,assumingthegovernmentbalances itsbudgetonaverage.11Thishighertaxation impliesmoredistortions from taxationand thereforelowerproductivity.12The stimulus approach generatesuncer

taintyabout

which

programs

the

government

will

support,

and

this uncertainty can impede private productive activity. Therealizationthatgovernmentishandingoutpotsofmoneygenerates rent seeking andotherunproductivebehavior, leadingtocronycapitalism (forexample,aseminationalizedauto industry). Finally, a belief that government can moderate oreliminate recessions can encourage excessive risk taking andtherebygenerateinstability.Beforeadoptinga fiscalstimulus, therefore, it is imperative

toconsidertheevidencefortheKeynesianmodelsvalidity.Asitturnsout,theempiricalsupportfortheKeynesianviewisfarfrom compelling.13 Themodel implies that the impact of in

11.SeeJohn F.Cogan et al., New Keynesian Versus Old Keynesian GovernmentSpendingMultipliers7(NatlBureauofEcon.Research,WorkingPaperNo.14782,2009),availableathttp://www.nber.org/papers/W14782.

12.SeeMartinFeldstein,TheEffectofTaxesonEfficiencyandGrowth1820(NatlBureau of Econ. Research,Working PaperNo. 12201, 2006), available at http://www.nber.org/papers/W12201.13.See, e.g.,AlbertoAlesina etal.,FiscalPolicy,Profits, and Investment,92AM.

ECON.REV.571,57374,579 (2002) (explainingambiguouseffectsonoutputandinvestmentfromgovernmentspending);AlbertoAlesina&SilviaArdagna,TalesofFiscalAdjustments,27ECON.POLY488,50809(1998)(examiningempiricaldataindicatingantiKeynesianeffectsfrom taxcuts);ChristinaD.Romer&DavidH.Romer,TheMacroeconomicEffectsofTaxChanges:EstimatesBasedonaNewMeasureofFiscalShocks,AM.ECON.REV.(forthcoming)(indicatingthattaxcutshavelarge,positivemultiplier effects);AlbertoAlesina& SilviaArdagna, Large Changes in

FiscalPolicy:

Taxes

Versus

Spending

13

(Natl

Bureau

of

Econ.

Research,

Working

PaperNo.15438,2009)(findingthatcontrollingforinitialconditions,aonepercentagepointhigher increase in thecurrentspending toGDPratio isassociated


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creasedspendingshouldbegreaterthantheimpactoftaxcuts,buttheexistingevidencesuggeststheopposite.14Indeed,someempirical evidence finds minimal impacts of spending, but

mostresearch

finds

arobust

impact

of

tax

cuts.15

Plausibly,

the

taxcutsareeffectivebecausecutsinthemarginaltaxratesoperate to increase efficiency regardless of their effectwithin aKeynesianframework.Thus, even if one takes thebasicKeynesian framework as

given and accepts that government should stimulate duringrecessions,existingevidencesuggeststhataneffectivepackageshouldconsistof lower taxes,especiallydecreased tax rates.16This approach is likely to be beneficial whether or not theKeynesian analysis is correctbecause reductions in tax ratesimprovetheincentivetowork,save,andinvest.Thisincreasedefficiencymeans higher productivity and income, so the net

impacton

the

deficit

can

be

smaller

from

awell

designed

tax

cutthanfromincreasedspending.Anotherway todescribe the choicebetween spending and

taxcuts is tonotethatunder increasedspending, thepoliticalprocessdecideshow to spend themoney,whereasunder taxcuts, consumers and firms get to decide how to spend themoney. Thus, the crucial difference between the two approaches isnotwhetheroneaccepts theKeynesianmodelbutwhether onebelieves governments ormarketsmake thebestdecisions about allocating resources.With this perspective, I

witha0.75percentagepointlowergrowth);AlanJ.Auerbach&WilliamG.Gale,

ActivistFiscal

Policy

to

Stabilize

Economic

Activity

22,

24

(Natl

Bureau

of

Econ.

Re

search,WorkingPaperNo.15407,2009)(indicatingthatgovernmentspendinghasasmallerimpactoninvestmentthantaxcuts);RobertJ.Barro&CharlesJ.Redlick,Macroeconomic Effects From Government Purchases and Taxes 2628, 3132 (NatlBureauofEcon.Research,WorkingPaperNo. 15369, 2009) (indicating that taxcuts have aGDPmultiplier greater than one,whereasdefense spending has aGDPmultiplierof0.60.7);AndrewMountford&HaraldUhlig,WhatAretheEffectsofFiscalPolicyShocks?3(NatlBureauofEcon.Research,WorkingPaperNo.14551,2008)(findingtaxcutsprovidestrongerstimulusthangovernmentspending);ValerieA.Ramey,IdentifyingGovernmentSpendingShocks:ItsAll intheTiming27 (Oct.2009) (unpublishedmanuscript,on filewithUniversityofCalifornia,SanDiego) (finding thatgovernment spendinghasamultiplierbetween1.0and1.1andresultsinanegativewealtheffect).14.SeeMountford&Uhlig, supra note 13, at 3; see alsoOlivier Blanchard&

RobertoPerotti,AnEmpiricalCharacterization of theDynamicEffectsofChanges in

Government

Spending

and

Taxes

on

Output,

117

Q.

J.

ECON.

1329,

1347

(2002).

15.Mountford&Uhlig,supranote13,at3.16.Seeid.


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nowconsiderthespecificelementsinthestimulusbillthatCongressadoptedandPresidentObamasigned.

II. TAXCUTSANDTRANSFERINCREASESThelargestcomponentsofthestimulusbillaretaxcutsand

transfer increases aimed at low to moderate income households.17Thiscategoryincludedapayrolltaxcreditin2009and2010, an increase in the alternative minimum tax floor, increasedspendingonMedicaid,extendedunemploymentbenefits, andmoremoney for food stamps.18A few tax cutswereaimedatbusinesses,includingaprovisiontoallowdeductionsofcurrentlossesagainstprofitsmadeinearlieryears.19Thecrucialfeatureofthesechangesintaxandtransferpolicy

isthatmostwerenotreductionsintaxratesandthereforedid

not

improve

incentives.

Some

of

these

provisions

are

neutral

regarding incentives. For example, payroll tax credits andcheckssenttoSocialSecurityrecipientsarelumpsumredistributions. Yet many other changes, such as extended unemployment insuranceandadditionalspendingonMedicaid,reducetheincentivetowork.Theyarenotreductionsintaxrates,whicharedesirableunderboththeKeynesianandcostbenefitviews of fiscal stimulus.What changes in tax policywouldhavebeensensiblefromboththeKeynesianandefficiencyperspectives?Twoinparticularstandout.Thesinglebestchangewouldhavebeeneliminationofthecor

porate income tax.Thiscomponentof the current tax system is

utterly

misguided,

independent

of

Keynesian

considerations.

The

corporateincometaxmeansdoubletaxationofcorporateincome,whichdistortstheincentivetosaveandinvest,therebyloweringproductivityandgrowth.Thecorporateincometaxaddsahugelevelofcomplexitytothetaxcode,reducingthetransparencyofcorporateaccounting.Thestandarddefenseofthistaxreliesonadesire to redistribute income and assumes that the tax falls onhighincome taxpayers because they own a disproportionate share of corporations. The tax, however, likely affects labor as

17.Getting to$787Billion,supranote4 (listingover$200billion in individual

tax

cuts

and

less

than

$10

billion

net

business

tax

cuts).

18.Id.19.Id.


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much ormore than shareholders, especiallybecause corporateincometaxationdrivescorporateactivityoverseas.Inadditiontomakingsenseoncostbenefitgrounds,areduc

tionin

corporate

taxation

is

entirely

consistent

with

the

Keynesianframework.Yet,becauseitalsoimprovesincentives,itshould increaseoutputoverandbeyondanyKeynesian impact. This increased efficiencywould generate higher outputandtaxrevenue,sofuturetaxhikescouldbelessthanthecutinthecorporateincometaxandstillbalancethebudget.A second change in taxpolicy thatmakes sense fromboth

the Keynesian and costbenefit perspective is a reduction inemployment taxes such as those for Social Security orMedicare. Thiswould lower the costs of hiringworkers, therebystimulating increased employment. This change would alsoimproveeconomicefficiencybecause employment taxesarea

wedgebetween

worker

willingness

to

work

and

firm

willing

nesstohire.Areductioninemploymenttaxeswouldespeciallybenefit low tomoderateincomeworkers,precisely thegrouptargetedbytheotherpoliciesinthestimuluspackage.Taxesdedicated toSocialSecurityandMedicareare, inany

case,notgoodpolicy.They exist toperpetuate themyth thatanygiven individuals contributionspay for that individualsbenefits,butbecause the systemsare runonapayasyougobasis,thisstoryisjustpoliticalspin.Eliminatingtheseseparatetaxes, and if necessary raising other taxes,would produce asimplerandmoretransparenttaxsystem.Thebottomlineontaxcutsandtransferincreasesisthatanal

ternativepackage,

focused

especially

on

reducing

or

eliminating

the corporate income tax and on lowering employment taxes,wouldhavebeenat leastasdefensible from theKeynesianperspectiveand farmoredesirable from the efficiencyperspective.TheAdministrationmissedanexcellentopportunitytoreduceoreliminatetheseundesirablefeaturesofthecurrenttaxcode.

III. SPENDINGTOPROMOTEENERGYEFFICIENCYThesecondmajorcomponentofthestimuluspackageispro

grams to increase energy efficiency.These include tax creditsforinvestmentsinrenewableenergy,fundingforasmartelec

tric

grid,

upgrading

government

vehicles

to

be

more

energy


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efficient,fundingforstatestoundertakeenergyefficiencyprograms,andsoon.20Advocatesoftheseparticularprogramsarguethatincreasedenergyefficiencyreducesairpollution,low

ersreliance

on

foreign

oil,

and

slows

global

warming.

Even

if

these claims are valid, however, government attempts to increaseenergyefficiencyareproblematiccomponentsofafiscalstimuluspackage.First,manyof theseprograms require time toplanand im

plementproperly, so spendingeitheroccurs too late tocounteract the recession or risks being done badly because it isrushed.A secondproblem is that energyefficiencyprogramsare not likely to use unemployed resources. Instead, theymerely shift employment from existing uses to governmentuses. Thismakes it evenmore important that the increasedspendinggo toprojects thatpassa standard costbenefit test,

whichis

again

difficult

when

the

spending

is

rushed.

Thethirdproblemisthatenergyefficiencyprogramsareineffectivemethodsof reducing energyuse.Considerupgradesof the federalgovernmentsvehicle fleet.Hybrid cars requireless energy to operate than standard cars, but hybrids costmore thanstandardcars,and thesehighercostsresult inpartfrom additional energy required for theirmanufacture.Thus,upgrading the fleetmight not reduce energy use and couldevenincreaseit.Rather than trying topromote energyefficiencywith slow

actingand ineffective energyprograms, the rightapproach ishigher energy taxes,which directly raise the price of energy

anddiscourage

its

use.

Much

of

the

infrastructure

necessary

to

collectthesetaxesalreadyexists.21Thedegreetowhichenergytaxes raiseprices isobservable.Thus,gauging themagnitudeoftheinterventionisstraightforward.Therightwaytoreduceenergyuseandstimulatetheecon

omy,therefore,istoincreaseenergytaxeswhileloweringothertaxesenoughtooffsetthehigherenergytaxesandprovidethedesiredamountofstimulus.

20.

Id.

21.KennethP.Greenetal.,ClimateChange:Capsvs.Taxes,AM.ENTERPRISEINST.ENVTL.POLYOUTLOOK1,6(2007),availableathttp://www.aei.org/outlook/26286.


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IV. SPENDINGONINFRASTRUCTUREThethirdmaincomponentofthestimuluspackageisexpen

ditureson

infrastructure,

such

as

roads,

railways,

and

public

transportation.22 Inaddition to theKeynesianjustification, theargumentforthisspendingisthatmanyinfrastructureprojectsgeneratebenefits inexcessofcostsandarenotproducedefficientlybytheprivatesector.Theissuesraisedbythiscomponentofthestimulusaresimi

lartothoseraisedbyenergyefficiencyprograms.Choosingtherightprojectsandimplementingthemproperlytakestime,yetfiscal stimulus needs to happen quickly. Some infrastructurespending merely shifts employment from other activities,rather than putting the unemployed towork. Political influences promote the projects in districts of key congressmen

ratherthan

those

with

the

greatest

ratio

of

benefits

to

costs.

The question for infrastructure spending,moreover, is notwhether some amount isbeneficial; the question iswhetheradditionalspendingon infrastructure isproductive,given theamounts alreadybeing spent. Ifmost of thebeneficial roadshavealreadybeenbuilt (for example, those connectingmajorcentersofpopulation indenselypopulatedpartsof thecountry),thennewroadswillbehighwaystonowhereandawasteofeconomicresources.

V. OTHERCOMPONENTSOFTHESTIMULUSPACKAGE

Beyondthemaincomponentsdiscussedabove,thestimuluspackageincludesabroadrangeofsmallerprojects.Theseprojectsraisesimilarissuestothosediscussedabove,soadetailedanalysis isnotnecessary.A fewbriefcommentsareneverthelessinorder.A significant component of the stimulusbillwas increased

expenditure forscientific research.23The incentives to invest inresearcharepotentiallyinsufficientfromtheperspectiveofsocietyoverall,andthecaseforgovernmentsubsidiesisreasonable.But the rightquestion iswhether theUnitedStatesneeds sub

22.Gettingto$787Billion,supranote4.23.Id.


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stantialadditionalgovernmentfundingrelativeto its2009funding levels.TheAdministration offeredno evidence to supportthisclaim.Itjustassumedthatbecauseresearchisgood,moreis

better.Research

spending

is

again

unlikely

to

use

unemployed

resources and instead enriches those already employedwhileshiftingresearchactivityfromtheprivatesectortogovernment.Anothersubstantialchunkofthestimulusconsistedoftrans

fers to state governments,24 some ofwhich took the form ofblock grants.This shift of spending from the federal governmenttothestatesispotentiallydesirablebecauseitmeanslesscentralizeddecisionmaking.The lions shareof the transfers,however,wastopubliceducation.25Thestatedgoalwastoreduceteacherlayoffs,26andthatundoubtedlyoccurredtosomedegree.Yetmanyschooldistrictshaveexcesspersonnel(assistantprincipals,specialistsforeverything),andlayoffsmightbe

appropriate.Some

of

the

federal

money

will

end

up

as

higher

wages forunionized teachers.States,moreover,could improveeducation on their own via charters and vouchers, reducingcostswithout federal infusions.Thus transfers to stateswouldhavebeendefensibleifunconstrained,buttheymostlywerenot.

CONCLUSION

A fewweeks after President Obamas victory in the 2008election, adviser Rahm Emanuel quipped that [y]ou neverwantaseriouscrisistogotowaste...[becauseit]providestheopportunityforustodothingsthatyoucouldnotdobefore.27

Emanuel

was

correct:

The

situation

in

which

the

new

Admini

stration found itself constituted anunusualpoliticaldynamicthat,properlyused,wouldhaveallowed theObamaAdministrationbothtostimulatetheeconomyandmakeitmoreproductiveoverthelonghaul.TheAdministrationshouldhaveendorsedastimuluspackage

basedonarepealofthecorporateincometaxandreductionsinemployment taxes. This policy would have accomplished itsstatedgoals,and thebudgetary implicationswouldhavebeen

24.Id.25.Id.

26.

Id.

27.TomRaum,Analysis:ConfirmationofrecessionmaystrengthenObamaspushforantirecessionpackage,ASSOCIATEDPRESS,Dec.2,2008.


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lessnegative than thoseof thepackageultimatelyadoptedbecausethisalternativeplanwouldhaveenhancedratherthandetracted from economic efficiency. This approach would also

havebeen

difficult

for

Republicans

to

oppose.

YettheAdministrationdidnottakethisapproach,presumablybecauseitstruegoalswerenotjusteconomicstimulus.Instead, theAdministrationwanted to reward itsconstituencies(unions,environmentalists,publiceducation)and increase thesizeandscopeofgovernment.ThistacticisconsistentwiththeAdministrations policies in general.Across theboard, it hastakenabiggovernment,redistributionistapproach,whetherregardinghousing,unions,health, theauto industry, trade,antitrust,orfinancialregulation.TheAdministrationsviewappearstobethatgovernmentisbetterthanindividualsatdecidinghowtaxpayersgettospendtheirmoneyandthatgovernmentshould

engineerlarge

transfers

from

richer

to

poorer.

WhethertheAdministrationsstimuluspackagewillbesuccessful isstill tobedetermined.Iftheextraspendingendsupbeing productive, then the impact of the stimulusmightbepositiveonnet.Myownprediction,however, is that theprogramsadoptedwillgenerate largedistortionsand substantialwaste,withminorstimulusimpact.Thisisapitybecausemuchbetteralternativeswereavailable.

Documents

Case Against Fiscal Stimulus