Congress has passed the largest fiscal stimulus plan in our lifetimes. It is intended to pull the economy out of a progressively worsening recession and avert the possibility of a depression. The plan is a mixture of tax cuts and increased spending. Of the spending, about 10% will go into infrastructure, the rest will go into transfers. The theory is that the people will spend the tax cuts and those people who receive that spending as income will in turn spend, creating a multiplier effect. The result will be increased demand for goods and services leading to higher output, new hires to produce that output, and higher demand for inputs such as parts and support services that in turn lead to more economic growth. On its face, this all makes logical sense. In fact, there are hundreds of economic textbooks written since the end of World War 2 that describe economic stimulus as working in this fashion.
The trouble is, the argument is incomplete. It doesn’t explain how the fiscal stimulus was paid for. To see this, lets go back to the start of the stimulus process. Congress spends more and lowers taxes. Ignore the tax reduction for the moment. How did it get the funds to spend? Did it raise taxes? Did it borrow? Did it print money? It had to do one or more of these things. Clearly it did not raise taxes. If, in fact, it ran a larger deficit and borrowed the money then that might raise total spending now. However, taxes will have to be higher in the future to repay the borrowing. Just like an ordinary household can borrow today, but must repay the loan in the future. So with borrowing today the government may increase current spending but it must lower spending by an equal dollar amount in the future. There is no net stimulative effect. You might argue that the spending now might increase productivity enabling the debt to be repaid by more productive, and hence wealthier, future citizens. However, most of the stimulus plan is not directed at investment so there seems little reason to believe that it will increase productivity any more than it will lower it. Maybe the government expects to repay the borrowing by printing money. If so, people are used to inflation and will see through this. The result will be higher prices. What we are left with is that the spending increase now must be paid for by a tax increase in the future, The government share of the economy will increase at the expense of the private sector, but there is no long-run stimulus. The present administration appears to be a whirlwind of activity and ‘doing something’ while in fact not doing so at all. If it said it was going to do nothing, it would be doing as much. Should the government ‘do nothing? No. There is a massive amount the government could do that would expedite the end of the recession and put the country on a long term growth path, but that will have to be the subject of a future article