Now, About That Stimulus Bill

As I understand them, the Republicans’ main reasons for opposing the stimulus bill (0 votes in the House, 3 in the Senate) were: (a) the bill contains too much evil government spending, (b) it doesn’t spend money fast enough to affect the economy, and (c) it’s too big. There are really no grounds for bipartisan agreement on (c), especially since many Democratic economists believe the stimulus is too small given the yawning output gap. But even conceding for a moment that (a) and (b) are valid concerns, I’m still baffled by the reduction of state aid from $79 billion to $40 billion. (See the New York Times comparison here.)

According to the Center on Budget and Policy Priorities, states are facing new budget shortfalls of $51 billion this fiscal year (ends June 30) and at least $94 billion for next fiscal year. Direct federal government aid to states will do no more than partially fill those budget gaps and enable state and local governments to keep people employed instead of firing them – teachers, firefighters, etc. While one might have concerns about whether the government can spend money on new programs efficiently, in this case the money will go to basic services that the government is already providing. This is only wasteful if you take the extreme view that all government spending in general is wasteful and any excuse to reduce it is a good one (the old “starve the beast” argument). The money can be spent quickly, because all the mechanisms needed to spend it already exist. Even if it is spent over several months (because people earn their salaries over the year), it will still have an immediate stimulative effect, because people who have jobs spend a lot more than people who don’t have jobs. It will have a high multiplier, because every dollar of government payrolls counts as one dollar of GDP, so the multiplier on government salaries is roughly the multiplier on tax cuts plus one. And it will even save a little money in unemployment benefits.

There are a lot of things one can argue about in the Senate version of the stimulus, but this I just don’t understand at all.

14 responses to “Now, About That Stimulus Bill

  1. First, let’s knock off this talk of firing teachers and policemen. Here in California, if you fired every state employee, you would eliminate less than 50% of the budget deficit. The problem is the transfer payments, not the employees.

    Having said that, I think you could roll back education spending to whatever it was in the year 2000 and not see a difference in the outcomes. That should be about a 40% cut. We’ve been spending way past the point of price elasticity of performance for quite some time.

    The reason you don’t want more aid to the states is that doing so will keep them from having to make the tough decisions they need to make. Cut the transfer payments and fire some education department staffers.

  2. Charles R. Williams

    You could do worse than sending $79 billion to the states. The fact remains that state and local government spending is out of control and the day of reckoning can only be postponed. The chief villains here are the government employee unions. Their power must be broken to get our country back on track. They are however a key Democratic constituency which is, I think, why the Republicans want to spend less on this.

  3. Google “state university layoffs” (without quotation marks).

    Now, if you think government spending is a bad thing in and of itself, then you are happy about the recession-driven fall in tax revenues, because it forces a decline in public spending you were unhappy about to begin with. But otherwise the question is where government money should be spent, and I would start with things that state legislatures have already decided they need, but are cutting because of a fiscal emergency.

  4. It’s easy to understand why Republicans opposed state aid- it’s a transfer from those states who balanced their budgets and managed their finances conservatively, to those states who spent recklessly and caved to government employees unions’ above-market demands. These politicians were elected to represent the people in their districts, and the people don’t want to see their tax dollars go to over-paid government employees of some other state.

    And some Republican politicians may believe that the federal government shouldn’t bail out states with spending problems due to the moral hazard, the precedent it sets, and the unfairness to the other states that made the hard choices.

    You’re free to disagree with this decision by those elected Republican politicians, but I think it’s highly inappropriate to say that this is beyond the boundaries of debate.

    P.S. I really like the economics analysis of this blog, but sometimes the liberal political bent can get annoying. There are plenty of liberal opinion blogs out there, so please stick to the economics, which you guys do better than just about anybody!

  5. I can see the positives and negatives of providing state stimulus. Given the amount of “other” components the ARRA contains, I agree the state cut is nominal and not one of the major issues to focus on (for the House or Senate).

    However, I do not think this is the venue to provide States with funding. The states need funding, but it should be separated from this bill.

    States operating at a deficit need to figure something out, but providing the states with more money does not seem like a viable solution (while it may marginally stimulate the economy). If we are saying the banks essentially need to fail, why is this approach (or a similar) not taken with the states. Obviously we do not want the states to fail, but a major overhaul and reconstruction may be required. If we are going to ask for the bankers to be held accountable with taxpayer (federal) dollars, why aren’t we asking the state for the same level of accountability?

    We are all calling for bankers to be accountable with these funds, but if we are providing the states with funding, shouldn’t we call for the same action?

    My concern with providing the states with money is the ARRA has too many cooks in the kitchen, with their own political agenda, and the bill has been diverted away from what it needs to be: bring confidence and lending to the banks, reducing foreclosures and reviving our economy back to positive GDP.

    Unfortunately, other (political) agendas come into play and the focus is diluted.

    If states needs funding, it should be separate to this to properly assess, and be able to discern corrective action. How much is needed? What steps are going to be taken? How are the states being held accountable?

  6. Well, after quickly scanning the comments on this article, I can safely say that we’re doomed.
    The U.S. and world economy are on the edge of catastrophe and the well-meaning, and thoughtful people who’ve made comments here are quibbling over $40 billion in state aid. I wonder if they are or were so vehement about the hundreds of billions of aid given to the banks?
    Anyway, if demand is not maintained while U.S. and other countries attempt to sort out the world financial system(nationalize the banks, etc.), then the fall in the general price level will broaden and increase. Once deflation gets going, there’s very little we can do about it. Millions and millions of people will be thrown into poverty and destitution here in America and in the rest of the G-8 countries.
    Well guys, save me a place on the breadlines!

  7. 46 out of 50 states are facing budget shortfalls: the exceptions are Montana, North Dakota, Wyoming, and West Virginia. Yes, all Republican states, but there are a lot more Republican states facing shortfalls. I don’t think this is an issue of transfer from Republican to Democratic states. (In general I believe federal taxes and expenditures are a transfer from Democratic to Republican states – mainly because Democratic states tend to be richer – although I don’t have a reference off the top of my head.)

    Also, on whether states are reducing workforce expenditures: at least 28 states have announced plans to lay people off, hire less, or reduce wages.

    According to first-year economics, you should not let government expenditures fall proportionally with tax revenues in a recession, because this has a procyclical effect. Instead, you should adopt countercyclical policies (and yes, you should also adopt countercyclical policies during booms), which requires deficit spending. In our unusual government structure, a large proportion of total government spending is done by state and local governments. However, they do not have the ability to borrow money that a national sovereign government has. If we don’t provide federal aid to states, we are letting a quirk of our political system (federalism) prevent us from taking an appropriate response to the recession. (Again, if your goal is to reduce government spending of any kind under any circumstances, then you are happy about all this.)

  8. As the WSJ stated this morning, this “stimulus” bill is a Trojan horse for increasing the size of government through wasteful and non-stimulative spending.

  9. Why not revamp the FED-JFK delivered a presidential directive that the FED could not loan the government $$$ at interest. The constitution does not provide for a central bank (Privately owned)-Secondly the USA has over 700 military bases overseas-should we see some dramatic cuts here.-No one mentions the role of our HUGE military expenditures and the debt incurred, to make the world SAFE for CORPORATIONS. Perhaps shutting down 50% of our overseas bases would help and EXPOSING the BUDGET of the CIA.

  10. Kwak:

    When you cannot pose the opposition’s position in a reasonable fashion, that’s a red flag that you’re thinking with your partisan-cap.

    The core Republican objections are:
    1) Not all spending works as stimulus. This point was made pithily by Senator DeMint, and uncharitably ridiculed by Obama. You might disagree, but this is a valid point of intellectual dispute.
    2) Most of the spending (~80%) happens a year or more from now, and is thus very mistimed.
    3) The cost of the stimulus package is very large–with very substantial crowding-out effects in the debt markets–and there are substantial uncertainties about whether it will be helpful or harmful. In short, its size makes it a risky gamble.

  11. Dear Jon,

    If the Republicans were worried about timing(that the spending won’t happen for another year), then why did they cut the aid to states which would have had immediate effects in maintaining economic demand?
    By the way, I’m a supporter of the Working Families Party and would like to point out that the Clinton Democrats, who finished deregulating finance ten years ago, are just as responsible for this economic catastrophe as the Republicans are.

    Sincerely,
    Ed Beaugard

  12. Ed: I can think of a few reasons, but intention is an individual thing.

    1) There was a Republican proposal to make the state aid a loan.
    2) State aid is neither the most immediate nor the most effective way of boosting investment.

  13. Dear Jon,

    So what is the best way to boost investment and create jobs? I suppose you’ll say tax cuts to business, but haven’t studies shown that these don’t work?
    The one bad thing about the stimulus bill is that it was such a mix of things, I almost prefer that we could have let Republicans(and some Democrats) have their way, that is, do a bill completely made up of tax cuts. In my opinion, it would not have worked, tens of millions of Americans would have been thrown into poverty and destitution, BUT at least we would know that tax cuts are useless. The way things are now, because the bill is half tax cuts, half government spending each side will be able to blame the other for its failure.
    And, in conclusion, haha, for any and all still reading this thread, why is the European Social-Democratic so bad? Their poverty rates are much lower than ours, their populations aren’t illiterate like ours, they make pretty good decisions about energy, i.e. France relying on nuclear power for example. So, what’s not to like?

    Sincerely,
    Ed Beaugard

  14. Ed: The best way to generate jobs is to curtail the supply of treasuries. Treasury auctions are very clearly bleeding investment pools dry. If the auctions stop, treasury yields will drop. People with money to invest will be more inclined to seek higher yields elsewhere (in productive activities).
    (Remember: the treasury typically borrows 100B in the gradual course of a year whereas in a matter of months nearly 1 Trillion has been borrowed. Remember Robert Rubin and the Crowding-out Effect?)

    Moreover, the Treasury of late has been sterilizing the money supply substantially. Nearly 500B is being held on account from recent auctions. This is very unusual. (100x unusual). This amounts to a significant contraction of high-powered money.

    Take a look at:
    http://lostdollars.org/static/deflation.png

    You can see that despite the best efforts of the Fed, high-powered money has declined substantially. This is due both to the Treasury’s cash hoard and because Fed policy has been draining liquidity from the broader market and boosting bank reserves, but bank lending is flat so most of the money is sterilized.