Everything you need to know about government stimulus programs (read this – it’s about your money)

Summary:  This post gives a brief description of government stimulus programs, based on theory and past experience.  Although there is a strong and broad consensus among economists on these things, it is not unanimous.  And there is debate on about many aspects — esp how to balance short-term needs and long-term costs.   

This is a follow-up to A situation report about the global economy, as the flames break thru the firewalls.

Contents

1. Fiscal stimulus is a palliative, not a cure
2. Long term vs. Short term stimulus
3. Which stimulus programs work best?
4. What stimulus measures give the most “bang for the buck”?
5. What types of tax cuts and transfer payments have powerful short-term effects?
6. Who can we trust?  Who has the best economic research?
7. Sources, where to go for more information
8. Afterword and other posts about this on the FM website

Before you begin, please say a prayer for Obama — elected as the economy slides off a cliff.  FDR took office in March 1933, at the worst point of the Great Depression.  He would not look so good to us if elected in March 1931.

1.  Fiscal stimulus is a pallitative, not a cure

Government stimulus provides support to the economy during hard times and minimizes suffering.  No cures, no sparks to make the dead walk.  From the abstract of “What Ends Recessions?“, Christina D. Romer and David H. Romer, NBER,  June 1994:

This paper analyzes the contributions of monetary and fiscal policy to postwar economic recoveries. We find that the Federal Reserve typically responds to downturns with prompt and large reductions in interest rates. Discretionary fiscal policy, in contrast, rarely reacts before the trough in economic activity, and even then the responses are usually small. Simulations using multipliers from both simple regressions and a large macroeconomic model show that the interest rate falls account for nearly all of the above-average growth that occurs early in recoveries.

2.  Long term vs. Short term stimulus

Supply-side measures, such as permanent tax cuts, have powerful long-term effects — but do little during a recession.  Demand-side measures for a recession have different requirements.  From “Economic Stimulus: Evaluating Proposed Changes in Tax Policy“, CBO, January 2002:

Supply-side incentives (that is, those that increase people’s willingness to save or work) are essential for economic growth in the long run, but they do not directly address the current problem of the economy’s short-term inability to use its existing capacity to produce goods and services. Consequently, the standard for judging the likely success of tax policy for countercyclical purposes is different from the standard for evaluating the policy’s contribution to long-term growth.

The effectiveness of tax cuts in stimulating an economy with slack capacity is largely determined by their ability to boost demand rather than supply. Tax cuts to stimulate economic activity in a recession do so by spurring additional demand. A tax cut is an effective fiscal stimulus if it creates sufficient demand to engage more of the economy’s existing productive capacity. A number of tax policies that are potentially desirable over the long term would generate little short-term stimulus.

A tax cut provides short-term fiscal stimulus when it increases consumption or investment demand. Consumption by households is generally stimulated when either after-tax income or lifetime wealth rises because of a reduction in taxes. Investment by businesses is typically stimulated when a tax cut boosts the aftertax return on capital sufficiently to make it profitable to invest more. In general, tax cuts designed to encourage more consumption are effective if they leave consumers with additional spending power. The bigger the chunk of their income that consumers are willing to spend instead of save, the more stimulus there will be from a particular tax reduction.

Tax cuts are a powerful tool for long-term economic vitality.  Of course, cutting taxes to increase the deficit is certain suicide — eventually.  With a total liability of $65 trillion (approaching 5 times GDP), America is accelerating towards a cliff (see the 2008 Financial Report of the United States Government for the ugly details).

3.  Which stimulus programs work best?

Experts recommend a cocktail of programs, as each has advantages and disadvantages.

Tax cuts or “rebates” work fast but with astonishingly low level of effectiveness, as they will mostly be used to pay down debt or increase savings.  Only 17% of the $177 billion 2008 rebates was spent, slightly less than that of the 2001 rebate.

Direct payments — food stamps, welfare, unemployment insurance — work fast with a high level of effectiveness.  They support consumption (aggregate demand), mitigate suffering — but have no long-term benefit.

Building infrastructure creates jobs — but for a relatively small number of skilled tradesmen and a million immigrants from Mexico (attracting back many who left following the crash in housing construction).  And its slow.  Jack Wells, Chief Economist for the Dept of Transportation, said:

“Finally, it takes a long time for these jobs to be created. Infrastructure construction requires a long series of steps to plan, design, get environmental clearance on, and construct infrastructure projects. Only about 27% the funds, on the average, are actually spent (“outlayed”) in the first year, while another 41% are spent in the second year.”

Eventually, if the downturn persists, we will resort to New Deal programs like the Public Works Administration, the Civil Works Administration, and the Works Projects Administration. See this article in Slate by Charles Peters and Timothy Noah for more information.

4.  What stimulus measures give the most “bang for the buck”?

Just what you would expect from the previous report.  Poor people spend their money, esp during recessions — giving aid them a relatively high level of impact.  From  “The Economic Outlook and Stimulus Options”, Mark Zandi ( Chief Economist of Moody’s Economy.com), Senate Budget Committee, 19 November 2008 — Table #1 on page 10.

5.  What types of tax cuts and transfer payments have powerful short-term effects?

Temporary Increase in Food Stamps	1.73
Extending Unemployment Insurance Benefits	1.63
Increased Infrastructure Spending	1.59
General Aid to State Governments	1.38
Payroll Tax Holiday	1.28
Refundable Lump-Sum Tax Rebate	1.22
Across the Board Tax Cut	1.03
Non-refundable Lump-Sum Tax Rebate	1.01
Extend Alternative Minimum Tax Patch	0.49
Make Dividend and Capital Gains Tax Cuts Permanent	0.38
Make Bush Income Tax Cuts Permanent	0.31
Cut in Corporate Tax Rate	0.30
Accelerated Depreciation	0.25

Government money to the poor both helps those most affected by a recession and has the greatest cost-effectiveness.  From “Options for Responding to Short-Term Economic Weakness“, CBO, January 2008 (Color italic  emphasis added), pages 6-7:

Cost-Effectiveness. In general, stimulus may be generated through policies that affect the spending of households, businesses, or government. The cost-effectiveness of stimulus varies within those categories of policies as well as across them. The same dollar amount of spending increases or tax reductions can have significantly different effects on overall demand, depending on how it is provided and to whom.

Households. In general, tax cuts or increases in transfer payments from the government to people (such as Food Stamps or unemployment insurance benefits) increase household demand by providing consumers with additional spending power.  The bigger the chunk of that additional income that consumers are willing to spend instead of save, the more stimulus there will be from a particular tax reduction or increase in government transfer payments.  But households do not predictably spend a fixed proportion of the extra income left in their hands when taxes are reduced or transfers are increased. Rather, a household’s propensity to consume appears to vary with its income and depends on expectations of the household of what will happen to that income over the longer term. A household’s consumption also varies for other reasons that are little understood.

Households are particularly likely to spend a greater share of a temporary reduction in taxes or additional transfer payments if they are credit constrained (that is, they have borrowed as much money as creditors will lend them). Given that these households would probably borrow additional money if given the opportunity, they are unlikely to save additional income. They are therefore likely to spend a greater proportion of a tax reduction or a transfer increase than other people who have access to credit.  Lower-income households are more likely to be credit constrained and more likely to be among those with the highest propensity to spend. Therefore, policies aimed at lower-income households tend to have greater stimulative effects.

The cost effectiveness of tax cuts is low unless tightly focused.  Only 17% (roughly) of the 2008 tax rebates were spent, slightly less than the 2001 rebates.  Poorly targeted for effectiveness, all we have to show for it was a brief bounce in the economy and another $177 billion in government debt.  As shown in this study:  “What Ends Recessions?“, Christina D. Romer and David H. Romer, NBER,  June 1994

Only 1/5 of survey respondents said that the 2008 tax rebates would lead them to mostly increase spending. … The survey estimates imply that the marginal propensity to spend from the rebate was about one-third and that there would not be substantially more spending as a lagged effect of the rebates. … Because of the low spending propensity, the rebates in 2008 provided little “bang for the buck” as economic stimulus.

As economist David Rosenberg wrote about the new stimulus plan on 20 January 2008:

“Of the tax cuts, the bulk is in credits, once again to low-and middle-income households.  Since this had virutally no effect on consumer spending in last year’s 2nd quarter, we would not expect much of a response to this type of stimulus this time around, esp. with the credit contraction, economic recession, and asset deflation backdrop much more deeply entrenched.”

6.  Who can we trust?  Who has the best economic research?

It’s 21st century America, and the only illegal whores are those on the Streets.  Doctors and lawyers lie in the courts.  Scientists shade the truth for grants.  As for economics — with the government the largest source of wealth, power centers (left, right, business, labor, greens) hire economists to say whatever is needed to get their share of the swag.

The academic literature is largely incomprehensible to laypeople — so still relatively reliable (why buy a product few understand).  Even more useful is the work of the Congressional Budget Office.  With Congress so evenly balanced for so long, they have been able to maintain objectivity.  Their reports are based on academic literature (properly cited for reference), but written in a rigorous clear manner understandable by laypeople.

7.  For more information

Codes:

• CBO = Congressional Budget Office
• NBER = National Bureau of Economic Research

Research about government stimulus programs:

Note:  Christina Romer is the new Chairwomen of the Council of Econmoic Advisers.

1. “Economic Stimulus: Evaluating Proposed Changes in Tax Policy“, CBO, January 2002
2. “The Macroeconomic Effects of Tax Changes:  Estimates based on a new measure of fiscal shocks“, Christina D. Romer and David H. Romer, UC Berkeley, March 2007 (68 pg)– Largely bout tax increases.
3. “The Economic Outlook and Stimulus Options”, Mark Zandi ( Chief Economist of Moody’s Economy.com), Senate Budget Committee, 19 November 2008 — See Table #1 on page 10.
4. “The Job Impact of the American Recovery and Reinvestment Plan“, Christina Romer and Jared Bernstein, 9 January 2009
5. “Options for Responding to Short-Term Economic Weakness“, CBO, January 2008
6. “The Job Impact of the American Recovery and Reinvestment, Plan“, Christina Romer and Jared Bernstein, The Presidential Transition Project, 10 January 2009 (14 pg)
7. “H.R. 1, American Recovery and Reinvestment Act of 2009“, CBO, 26 January 2009
8. “The State of the Economy and Issues in Developing an Effective Policy Response“, Douglas W. Elmendorf (Director, CBO), 27 January 2009 (30 pg)
9. “Painful Medicine“, Laurence Ball, Daniel Leigh, and Prakash Loungani, Finance & Development, September 2011 — “Although advanced economies need medium-run fiscal consolidation, slamming on the brakes too quickly will hurt incomes and job prospects”

A selection from the vast research about infrastrcure spending:

1. “Contribution of Highway Capital to Industry and National Productivity Growth“, M. Ishaq Nadiria and Theofanis P. Mamuneasc, prepared for the Federal Highway Administration, September 1996 (130 pages) — They found the contribution is positive, but far smaller than previously estimated — and has been falling over time.
2. “Contribution of Highway Capital to Output and Productivity Growth in the US Economy and Industries“, M. Ishaq Nadiria and Theofanis P. Mamuneasc, August 1998 — Updating and expanding their 1996 study.
3. “Trends in Public Spending on Infrastructure“, Joseph Kile (CBO Assistant Director for Microeconomic Studies), 5 February 2008 (PDF, 13 slides)
4. “Issues and Options in Infrastructure Investment“, CBO, May 2008 (52 pages)
5. “Issues in Infrastructure Investment“, Joseph Kile (CBO Assistant Director for Microeconomic Studies), National Tax Association Conference, 26 September 2008 (PDF of 10 slides)

8a.  Afterword

Please share your comments by posting below.  Per the FM site’s Comment Policy, please make them brief (250 words max), civil, and relevant to this post.  Or email me at fabmaximus at hotmail dot com (note the spam-protected spelling).

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8b.  For more information from the FM site

To read other articles about these things, see the FM reference page on the right side menu bar.  Of esp interest these days:

• About the Financial crisis – what’s happening? how will this end?.
• Good news about America, a collection of articles!

Other posts about solutions to the economic crisis:

1. A happy ending to the current economic recession, 12 February 2008 – The political actions which might end this downturn, and their long-term implications.
2. Slow steps to nationalizing the US financial sector, 7 April 2008 — How this will change our society.
3. Slowly a few voices are raised about the pending theft of taxpayer money, 21 September 2008
4. How should we respond to the crisis?, 24 September 2008
5. A solution to our financial crisis, 25 September 2008
6. A quick guide to the “Emergency Economic Stabilization Act of 2008″, 29 September 2008
7. The Paulson Plan will buy assets cheap, just as all good cons offer easy money to the marks, 30 September 2008
8. The last opportunity for effective action before disaster strikes, 3 October 2008
9. Effective treatment for this crisis will come with “The Master Settlement of 2009″, 5 October 2008
10. Dr. Bush, stabilize the economy – stat!, 7 October 2008
11. The new President will need new solutions for the economic crisis, 9 October 2008
12. New recommendations to solve our financial crisis (and I admit that I was wrong), 23 October 2008
13. A look ahead to the end of this financial crisis, 30 October 2008