The Case for Economic Stimulus

A sharply deteriorating economy requires bold but well-targeted action by Congress and the Obama administration, writes Will Straw.

House Speaker Nancy Pelosi and Minority Leader John Boehner shake hands before opening the 111th Congress on January 6, 2009. (AP/Pablo Martinez Monsivais)
House Speaker Nancy Pelosi and Minority Leader John Boehner shake hands before opening the 111th Congress on January 6, 2009. (AP/Pablo Martinez Monsivais)

View an infographic on four reasons why we can’t afford not to have a stimulus

The U.S. economy is facing its most serious economic challenge since the Great Depression. Companies shed 2 million jobs in 2008 alone and the economy has now been in a recession for over a year. Policies promoted by the Treasury and the Federal Reserve have failed to halt the recession. Economic recovery legislation is urgently needed to prevent an ever-worsening spiral of economic decline and job loss. The proposals reportedly under consideration by President-elect Barack Obama and congressional leaders are promising. Their magnitude is appropriate and—because we face a prolonged period of severe economic distress—it is also appropriate that the plan bolsters the economy over the next two years.

The scale of the economic crisis means that a big recovery package is necessary. As Scott Lilly argues in his report, “Pumping Life Back into the U.S. Economy: Why a Stimulus Package Must Be Big and Targeted,” we may need a stimulus of $650 billion to $700 billion. New York Times columnist and Nobel prize-winning economist Paul Krugman suggests that the number may have to be even higher still. The good news is that the United States has the resources to do so, and cannot afford not to shirk this challenge. The cost of inaction from economic contraction in terms of lost jobs and failing businesses would be catastrophic.

A well-designed economic recovery package can achieve four goals: quickly boost the economy to break the recessionary spiral and create jobs; help those most affected; build our future economic strength; and accomplish these objectives in a manner that uses our resources wisely. Each proposal should be assessed against how well it helps to achieve these criteria. If they are not up to scratch, they should be dropped.

To ensure that public money is not irresponsibly wasted, the legislation must break away from special-interest politics and conservative filibustering. Public money should be spent wisely and in the most effective way to address our economic woes. A rapid and aggressive economic plan must not be obstructed by demands for pet projects from either side of the congressional aisle or long-discredited conservative proposals such as permanent tax cuts for the rich.

There are four broad areas where the money can meet our progressive criteria and avoid the pitfalls of parochial politics:

  • Infrastructure investments, including green job creation
  • Assistance for those most in need
  • Aid for states and localities
  • Responsible tax cuts that spur demand

Building a clean-energy infrastructure will create new green jobs for today’s struggling construction and manufacturing workers, promote energy security, and help fight the effects of global warming. The Center for American Progress and the Political Economy Research Institute proposed last year $100 billion of measures to start moving the economy onto a new, green footing. It is estimated that this will create 2 million jobs over two years. Many of the green investment projects, such as weatherizing public buildings, are labor intensive in construction and manufacturing sectors where unemployment is high, and they will therefore create jobs where they are most needed. Much of this expenditure could start stimulating our economy relatively rapidly, including energy efficiency and conservation block grants, transit fare reductions, and “ready-to-go” local transit infrastructure.

Other infrastructure investments for transportation, utilities, schools, health, and broadband would also create jobs efficiently and, in many cases, filter into the economy quickly. States and other organizations have identified billions of dollars of “ready-to-go” projects, including essential repairs and maintenance to highways, airports, and schools. Mark Zandi, the founder of Moody’s, estimates that infrastructure measures generate a $1.59 increase in GDP for every $1 that is spent.

Perhaps the most effective way to get money into the real economy quickly and curb a downward recessionary spiral is through federal aid to states and localities. Because of balanced budget rules, states and local governments are being forced to slash services such as Medicaid while workers are being laid off. Aid to states keeps people in jobs and provides a necessary local kick to the economy. As Nobel Prize winner Joseph Stiglitz has written, “States are facing massive revenue shortfalls; without assistance, they will have to cut spending, plunging the economy into deep recession.”

A quick way of ensuring that federal dollars boost demand is by targeting those most in need. Zandi estimates that the two programs which get the most “bang for your buck” are extended unemployment insurance benefits and temporary increases in food stamps. Such provisions are particularly helpful because those hardest hit are most likely to spend the money they receive to help the economy instead of saving it or paying down debt (worthy steps from a personal standpoint but not what the economy needs right now). Measures that target those most in need generate $1.64 and $1.73 respectively for every dollar spent, according to Zandi. These measures can protect the most vulnerable families and help get the economy back on track.

For similar reasons, the tax cuts that would most strengthen the economy are those focused on low- and middle-income families that are struggling to get by. The Wall Street Journal has reported that $300 billion of the stimulus will be spent on tax cuts. If this money is spent, rather than being saved or used to bring down debts, then it will certainly have a stimulative effect. The best way to ensure this is through the Earned Income Tax Credit and the Making Work Pay Credit. The latter will help about 150 million Americans making less than $200,000. Measures that target top earners, such as making the Bush tax cuts permanent, will be much less effective in stimulating the economy. As outlined by Citizens for Tax Justice, wealthier people spend a smaller share of their income, so a tax giveaway would be less effective. In any case, the Bush tax cuts do not expire until 2010 so making them permanent now would do little to help address the current economic crisis.

Temporary tax cuts for businesses may also be an effective way of stimulating the economy if they encourage future investment plans to be brought forward. They should not, however, simply act as a transfer to companies based purely on the size of their losses rather than their capacity to create new jobs. Letting corporations retroactively deduct current losses from past years’ taxes is particularly misguided since it would help some of the wealthiest financial players at the heart of the subprime mortgage crisis that created this economic downturn in the first place.

Permanent tax cuts for business such as a reduced corporate tax rate will also fail. The track record for such steps is poor in general, but they are particularly ill-suited for a recessionary period. After all, the reason that businesses and individuals are not investing at the moment has little to do with the taxes they may pay in the future and everything to do with a fear of losing money because there is no demand in the economy, asset prices are highly volatile, and credit is hard to come by.

The economy is on the brink of a prolonged and painful downturn. Existing attempts to boost demand by slashing interest rates have not worked, and the dramatic new lending facilities created by the Federal Reserve and Treasury have so far failed to get the banks lending again or raise consumer demand. No more time can be wasted on the old formulas or experimenting with new lending programs.

Instead, a large fiscal recovery package must be passed quickly by Congress to break the recessionary spiral and create jobs. In doing so it must help those most affected and build our future economic strength while achieving fiscal responsibility. There can be no place for special interests or ideological proposals. President-elect Obama and congressional leaders must ensure that earmarks and the failed conservative policies of yesteryear do not find their way into the bill. Speed is of the essence and the time for action is now.

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Will Straw