Arnold Kling Against The Stimulus

In The American

For a Stimulus, Against Pelosi’s Bill 

If you follow the news media, you may think that the economics profession is divided into two camps: the majority, who favor the stimulus bill; and a minority, who are against any stimulus. In fact, there are many of us who support the idea of a stimulus but who question the Pelosi bill. 

One group of skeptics is concerned about the state of the banking system. Tyler Cowen, quoted above, is in this camp. Their view is that with a dysfunctional financial system, fiscal stimulus may not work. Instead, we need to first figure out how to fix or work around the banking crisis. As someone within this group, I believe we need to work around the banks, because we are in a hedge finance phase, where firms need to fund investment out of profits. 

Another group of skeptics is concerned about the timing of the fiscal stimulus. Even some economists on the left, including Alice Rivlin and Jeffrey Sachs, have made the point that the long-term spending in the stimulus bill is inappropriate and even counterproductive from a stimulus perspective. I share this concern. President Obama said that his goal is to have 75 percent of the stimulus take effect before the end of 2010. Instead, I would argue that we should have 100 percent take effect by then, and 75 percent take effect by the end of 2009. 

The reason that the Democrats want to delay the stimulus is that they want most of the stimulus to take the form of spending increases, which cannot be handled effectively this year. Tax cuts could take effect more quickly, but the Democrats want to hold tax cuts to a minimum. Textbook Keynesian economics says that a spending increase will stimulate more powerfully than a tax cut, because part of a tax cut will be saved rather than spent.

 However, this same textbook analysis says that a stimulus now is more powerful than a stimulus that kicks in two years from now. Even though the multiplier for a spending increase may be higher than that for a tax cut that is enacted at the same time, we can be certain that the “multiplier” for a tax cut in 2009 is greater than the multiplier for a spending increase in 2011.

Finally, I have a concern about the “public choice” aspects of the stimulus bill, meaning the political distortions that make it an ineffective stimulus. If the only goal of the bill were to stimulate the economy, then the focus would be on trying to get the largest possible improvement in employment for a given increase in the deficit. A traditional stimulus proposal, going back to the 1960s, is a temporary investment tax credit. With such a credit, the government in effect provides matching funds for firms that undertake investment while the tax credit is in effect (say, through March of 2010). This would lead to spending increases that are a multiple of what the government contributes. 

Another proposal, which George Mason University’s Bryan Caplan has suggested, is a cut in the employer portion of the payroll tax. The extra kicker here is that it reduces the employer’s cost of labor, thereby stimulating hiring. I think an additional kicker is that this would restore profitability in the nonfinancial sector, helping to boost investment. Instead, the stimulus bill is directed largely at state and local governments. There is a lot of rhetoric about making sure that we do not lay off cops or teachers. But the fact is that millions of private sector workers are being laid off, while public sector layoffs so far have been fewer than one hundred thousand. The need for stimulus is in the private sector, but the political focus of the bill is on enlarging the public sector. 

Many economists are willing to overlook the flaws in the legislation and to sanctify Pelosi’s bill as a stimulus bill. Other economists reject Keynesian economics altogether. The economists that you hear less about are those of us who oppose the bill because of our reading of Keynes.