The Stimulus Plan - A Background

We have three theaters to monitor: 1) The Fed, 2) the Bank Rescue plan and 3) the Stimulus plan. The Fed runs the only game in town, for now (see earlier sketch). Nothing else is working. The administration’s Rescue plan is to be fleshed out in 10 days or so, armed with roughly half of the original $700 bln. We will follow that over the near term. Below is a guide to the Stimulus plan, taken up by the Senate this week.

There is ample evidence that tax cuts spark economic activity; there is very little that gov’t spending can do the same. Roosevelt’s programs did next to nothing to fetch the economy from the Great Depression. WWII did the trick. Some observers maintain that the government can increase its spending only by reducing private spending equivalently. From Rich Wagner at George Mason Univ, "Whether government finances its added spending by increasing taxes, by borrowing, or by inflating the currency, the added spending will be offset by reduced private spending. Furthermore, private spending is generally more efficient than the government spending that would replace it because people act more carefully when they spend their own money than when they spend other people's money."

Wagner may be correct but this is lost on Congress. Tax cuts amount to only one third (1/3) of the package ($500 credit for individuals/$1000 for couples). The balance is direct gov’t spending, or transfers. The CBO and the Joint Committee on Taxation have calculated that only $170 billion, or about one-fifth of the $816 billion package will be spent in fiscal 2009. An additional $356 billion will be spent in 2010. That leaves $290 billion to be spent when even the most pessimistic forecasters think the economy will be in recovery mode. Some of the longer-term investment projects proposed may be quite worthy; some are not. Either way, they are not stimulus. What the House Democrats have done is write down every single item on their wish list, append dollar amounts next to the items seemingly at random, and call it "stimulus." Nancy Pelosi was on TV recently justifying the "stimulus." "How," asks the reporter from CBS, "does $335 million in STD prevention stimulate the economy?"

Stimulus has to stimulate, right? Yet consider education. Of the $140 billion spending on education, some may move rather quickly, say the $13 billion over two years for Title I schools and for special education under the Individuals With Disabilities Education Act. Maybe. But also included are programs that even under the most optimistic timetable will take longer to complete, like $20 billion for school renovations. These would provide ZERO near-term help for the economy. Similar scrutiny could be trained on health care and especially on alternative energy programs. A large chunk of health care spending would not start until 2012 or later.

How may Congress best provide the spark? Well, try cutting the U.S. corporate tax rate -- at 35%, among the highest of all industrialized nations -- in half. Suspend the capital gains tax for a year to provide the incentive for new investment. Any fool knows this would work. Postponing the scheduled increase in the tax on dividends and capital gains would raise share prices, leading to increased consumer spending and, by lowering the cost of capital, more business investment.

Or, if Congress insists on spending, make it rapid, and, on something that needs to be done. How about including higher defense outlays, including replacing and repairing supplies and equipment, needed after five years of fighting? The military can increase its level of procurement very rapidly. Yet the proposed spending plan includes less than $5 billion for defense, only about one-half of 1 percent of the total package.

Robert Craven