I have been asked by several people for my thoughts on the proposed stimulus package. At the national level, the Wall Street Journal’s coverage is unsurpassed. At the state-level, the Oregonian editorial board best sums up the challenges of the stimulus package:
“But it’s folly to use bond money to remove moss that will grow back long before the work is paid for. The same can be said for all the painting, patching and other such proposals–pay-as-you-go maintenance that should be borne by the general fund.” – The Oregonian
The problems with spending as stimulus
* Spending is not timely. Most of the money will not get spent until the economy is already recovering. As noted in an earlier post, more than 85 percent of the stimulus spending will occur in 2010 and later. This has two impacts. First, it does nothing immediately to resolve the recession. Second, once the economy recovers, the public sector “stimulus” projects will compete against private sector investment attempts, driving up business costs.
* Spending is uncertain. While we know that some money will be spent on streetcars in Portland and a mob museum in Las Vegas, we do not know which contractors will actually win the bids to do the work. Businesses cannot make investments in an environment of tight credit and great uncertainty about which projects they will win and which ones they won’t.
* Spending is temporary; taxes are forever. Increased spending may create a feeding frenzy today, something I call Hog Trough Economics: Dump a bunch of feed in the trough and hope that the hogs crowding around the trough spill some feed on the ground for others to eat. Ultimately, the bill comes due. Paying for today’s stimulus will raise taxes for the next 20+ years. The expectation of higher taxes in the future stifles economic activity today.
Tax breaks can permanently stimulate the economy
A permanent cut in marginal tax rates can immediately stimulate the economy. Describing state and local tax cuts, an economist at the Federal Reserve Bank concludes:
“It appears that state and local taxes have temporary growth effects that are stronger over shorter intervals and a permanent growth effect that does not die out over time.”
Tax cuts are timely. They can be implemented immediately and applied retroactively. Permanent tax cuts cause businesses and households to rapidly adjust their spending and saving decisions. These decisions will be felt in the economy in weeks or months rather than years.
Tax cuts are certain. Every household and business knows how a change in tax rates will affect their bottom lines. They do not have to guess or hope that they will get some of the benefits. This certainty encourages investment, spending, and saving throughout all sectors of the economy.