Stimulating Government

Last week, the Senate Finance Committee upped the ante in the congressional “economic stimulus” sweepstakes with one of the largest one-time spending initiatives in history. The Finance Committee bill would increase federal spending by an estimated $47 billion dollars. The remaining $19 billion of the stimulus package would go toward tax cuts for businesses.

Using fiscal policy to stimulate economic activity is easier said than done. Some economists argue for a short-term infusion of cash to give the economy a “shot in the arm” through consumer spending. Others believe that tax and regulatory changes should be made to encourage businesses and entrepreneurs to take risks and invest. Still others argue that stimulus proposals should provide temporary displaced worker relief so as not to affect long-term interest rates. No stimulus package could possibly include provisions to satisfy every economist, nor could a bill be crafted to exclude provisions some economists might believe to be harmful.

If trained experts could scarcely craft a stimulus plan, it seems highly improbable that Congress could fare any better. The political compromises necessary to pass such legislation make the entire concept of fiscal stimulus illusory. The Senate Finance bill differs so greatly from the House tax-cut driven stimulus package that any compromise to emerge from a House-Senate conference would likely be worse than nothing at all.

The only identical provision in the bills is a proposed $13 billion rebate to non-income taxpayers. A spending plan dressed-up as a tax cut, this provision is unlikely to do much to help the economy. The rebate is heralded as a way to get money into the economy because the $300 checks would go to those Americans most likely to spend it. But as we learned in the last rebate go-round, transferring less than 1 percent of gross domestic product from the federal treasury to private bank accounts does not lead to an economic turnaround because it is too small to matter and does nothing to change incentives.

Both bills also provide a temporary increased deduction for business expenses to boost investment, but the Senate Finance bill limits the expensing to small businesses, while providing larger corporations with a 10 percent “bonus” depreciation for investment in capital and software placed in service over the next 12 months. The business tax provisions in both bills can help to stimulate investment because they mitigate the corporate income tax’s current bias against investment, but both bills make the relief so temporary that it is bound to produce inefficient results.

The corporate income tax discourages investment by artificially increasing the revenue necessary to make a profit on a capital project. Only a percentage of an investment can be deducted from a firm’s overall profits when calculating corporate income tax liability. Thus, the taxes on the profits derived from a new piece of machinery or computer system are greater than the write-off value of the investment. But reducing this tax penalty for 12 months could create a transitory period of overcapacity as firms are induced to shift priorities and speed ahead with capital projects. Those in charge of a firm’s balance sheets would do everything in their power to save as much in taxes as possible for that year.

Beyond these two provisions, the Senate Finance plan diverges greatly from that of the House in that it provides social assistance programs instead of tax cuts. In 2002 alone, the Senate bill would spend $12.3 billion for health insurance coverage for displaced workers; $14.3 billion in unemployment benefits; and $2.8 billion for agriculture assistance to offset low prices.

The problem with policies that make unemployment more pleasant is that they can make unemployment agreeable to the point where finding a new job quickly might not be as imperative. This is not the case for most people, but economic policy often has its effect on the margins where policies affect incentives and behavior. Everyone knows certain people that probably would be inclined to put off searching the classifieds if they knew that unemployment benefits would be coming in an additional six months.

The bill’s agricultural assistance provision would be in addition to the $167 billion in the Farm Bill passed by the House and would undermine the little progress that has been made in moving agriculture to a more market-oriented system. For instance, $10 million would go to buffalo ranchers who have supplied the market with far more Bison meat than was demanded and have seen their prices fall as a result. Overestimating demand is a common mistake made by profit-maximizing firms. By socializing the buffalo ranchers’ loss, the government diverts scarce resources towards a commodity that few consumers value.

The frightening thing about all of this is that this week the full Senate is set to vote on this bill. In all likelihood, the bill that passes the Senate this week will spend at least twice as much as the stimulus bill proposed by President Clinton in 1993, which was deemed “too costly” and defeated by a Senate with 56 Democrats. If this 51-49 Senate passes a bill twice as large, it will speak very poorly of the way policy priorities have changed in the past eight years.

Free market advocates are at an inherent disadvantage when it comes to “economic stimulus” debates because market solutions are not instantaneous and benefit the more efficient sectors of the economy, which are typically not the ones suffering from the downturn. “Get government out of the way” is the right policy message to stimulate growth, but the specific taxes to be cut or repealed to stimulate growth is a matter of debate. And regulatory relief, which could provide the most immediate dividends for consumers and the economy as a whole, is a topic almost always avoided in the stimulus debate.

Policies conducive to wealth creation and economic growth reward private risk taking, deferral of gratification, and industriousness. Conversely, government spending rewards political constituencies, thereby encouraging more lobbying and influence-peddling. Thus, the primary objective for anyone interested in stimulating growth is to constrain the size of government, because each dollar spent by the government is a dollar diverted from its most productive use.