Thursday, January 29, 2009

Is Obama's Stimulus Good for America?

Immediately after taking the reigns of the US government, Barack Obama began pitching his stimulus plan to Congress and the American people. We are being told, as we were told last fall by President Bush and Secretary Paulsen, that quick action is needed to rescue the economy. Once again, the government plan is to spend vast amounts of taxpayer money.

President Obama’s stimulus bill, the American Recovery and Reinvestment Act of 2009, is made up of almost $1 trillion in federal spending. The money is being spent on a variety of different programs over several years. About $318 billion would go to states and cities that are in budget crunches. This will enable those governments to avoid cutting spending or finding additional revenues on their own. $102 billion would go for unemployment benefits, healthcare, and food stamps for unemployed workers.

The bill also includes vast amounts of pork that is not related at all to the economic recovery. There is $2.8 million for the development of rural broadband service. $1 billion is earmarked for the 2010 census. The bill includes an additional $650 million for digital-to-analog television coupons. $400 million will pay for fisheries and habitat restoration. Another $400 million is designated for climate change research. Education gets $100 million. The Corps of Engineers gets $4.5 billion for flood control projects. Another $4.5 billion is designated to update the nation’s power grid. $50 million support the arts due to a decrease in philanthropic giving. Some of these projects are worthy and some are not. The common denominator is that the majority of them are totally unrelated to any financial recovery.

The bill does include $275 billion in tax cuts. Most of these tax cuts are targeted towards middle-income families. The proposal is a $1000 tax credits for families or $500 for individuals. While any tax cuts are a good thing, the economic impact of $1000 is very limited as we saw in 2008 when the government mailed out stimulus checks with practically no effect. Obama’s plan would also extend these credits to taxpayers who pay less than $1000 in taxes, essentially creating a new welfare payment.

There should also be tax cuts for businesses and upper-income individuals. According to the government’s own statistics, small businesses represent 99.7% of all companies and provide 60-80% of new jobs. They also account for more than half of the non-farm domestic product. If small business is the true engine of the economy, then it seems that small business is the segment of the economy that we should be trying to stimulate.

Additionally, we should consider the price tag of this expansion of federal government spending. The Congressional Budget Office estimates that the 2009 budget deficit would rise to a staggering $1.19 trillion under Obama’s plan. This would be a huge increase over the deficits of the Bush Administration. It would be more than double the record deficit of 2008 that included the previous stimulus and bailouts. As a percentage of the Gross Domestic Product, Obama’s deficit would be 8%, larger than the previous record from the 1980s. When government accounting tricks are taken into account, estimates of the total deficit range as high as 15% of GDP.

The United States also faces additional financial crises in the form of Social Security and Medicare. Both programs are scheduled to become insolvent over the next few decades, Medicare in 2019 and Social Security in 2041. To rescue these programs will require huge additional sums of cash that is not being considered in the current crisis.

Since the current stimulus package also includes provisions that would place unemployed workers on Medicare at government expense, the stimulus bill is also a step toward a nationalized health care system. The Democrats will eventually attempt to create a massive new health entitlement that will require billions of taxpayer dollars and eliminate thousands of jobs in the health care and insurance industries.

The obvious question is where the money is coming from. One option is for the government to simply print more money. This would lead to an increase in the supply of dollars. If you have had a basic economics course, you may remember that as the supply increases, the price, or value, decreases. Printing more money would lead to a decline in the value of the dollar and a rise in the rate of inflation. Simply stated, it would take more dollars to pay for things.

The more likely scenario is that Obama and the Democrats would plan to pay for their programs by raising taxes on “the wealthiest Americans.” Unfortunately, the wealthiest Americans are those American who own and operate businesses, as well as the businesses themselves. If taxes are sharply increased on the corporations and the wealthy, then there will be less money for those businesses to expand and hire new workers. This, in turn, means that the unemployment rate will continue to rise and the economy will continue to languish.

Of course, given the dire state of the US economy, if the Democratic plan will work, it might be worth its enormous price tag. We should look back through history to find out whether similar plans were successful.

The US government actually did try a similar plan in the 1930s. When the stock market crashed in 1929, the financial crisis led to the election of Franklin Delano Roosevelt. FDR attacked his predecessor, Herbert Hoover, for economic policies that led to the crisis. Interestingly, the policies of Hoover and the Republican congress included protectionism (the Hawley-Smoot Tariff) and raising taxes. In a 1932 speech, Roosevelt said, “Taxes are paid in the sweat of every man who labors because they are a burden on production and are paid through production. If those taxes are excessive, they are reflected in idle factories, in tax-sold farms, and in hordes of hungry people, tramping the streets and seeking jobs in vain.”

After the election, however, FDR continued these policies, but on a grander scale. Roosevelt’s economic policies became known as the New Deal. The New Deal consisted of large amounts of deficit spending, draconian regulation of business, and increased taxes. A dizzying array of new government agencies provided oversight of surviving businesses and employed thousands of Americans in make work jobs.

The National Industrial Recovery Act (NIRA) exempted businesses from antitrust laws if they agreed to union contracts that raised wages. This caused both prices and wages to rise artificially. Increased union power led to a dramatic increase in the number of strikes. Artificially high wages kept employment low and slowed the recovery. The NIRA was ruled unconstitutional in 1935, but even then the government simply chose not to enforce antitrust laws.

During the Great Depression, the unemployment rate peaked at 25% in 1933. Throughout the 1930s, it never dropped below 13% even with vast amounts of government spending and regulation. Gross domestic product (GDP) also never recovered to its pre-1929 levels until the US mobilized to fight WWII. Roosevelt’s ally, Treasury Secretary Henry Morgenthau put it best when he said, “We have tried spending money. We are spending more than we have ever spent before and it does not work ... After eight years of this Administration we have just as much unemployment as when we started ... And an enormous debt to boot!”

Japan also suffered a similar financial crisis in the 1990s. In 1990, the Japanese stock market, the Nikkei, crashed, eventually losing almost 60% from its 1989 high. At the same time, Japanese property prices collapsed, prompting a foreclosure crisis similar to our own. Rising foreclosures led to a credit squeeze. The Japanese people responded to the crisis by becoming more thrifty and risk averse. This caused a further shortage of capital and investment.

The Japanese government’s response was much like our own. In April 1992, Japan passed its largest stimulus package. Trillions of yen went for public works, business loans, and the Japanese Development Bank. Investment continued to fall while unemployment continued to rise. Japan’s debt grew to a phenomenal 68% of GDP.

As Japan’s economy remained in recession, the government (which changed ruling parties) implemented seven more stimulus packages over the next seven years. By the end of the decade, Japan’s debt was 128% of GDP. All the while, the economy remained stagnant. The Nikkei has still not recovered to its highs of the 1980s, but, as the Wall Street Journal notes, Japan does have good roads.

We can also look to the social democracies of Europe to see how a combination of high taxes, regulation, and government spending affect the economy. The United States typically leads Europe in productivity and job creation and productivity. The European nations that show the greatest economic growth are those that have low corporate tax rates and flat taxes. The list includes Ireland, Romania, Slovakia, and Estonia. France and Germany, heavily socialized countries, both recently elected pro-capitalist governments.

As we look back through history, we see that low tax rates have spawned growth in the United States as well. Four times in the past one hundred years, the US has enacted lower tax rates. In the 1920s, Treasury Secretary Andrew Mellon under Presidents Harding and Coolidge presided over a sharp decrease in tax rates. In the 1960s, President Kennedy, saying, “a rising tide lifts all boats,” also cut taxes. In the 1980s, President Reagan cut taxes again after inflation put many Americans into higher tax brackets during the 1970s. In the early 2000s, after inheriting a recession from Bill Clinton, President George W. Bush also enacted tax cuts.

Each time, the economy responded with growth. Additionally, the tax cuts served to increase federal tax receipts because people earn more when the economy grows. Furthermore, cutting tax rates serves to shift a greater portion of the tax burden to upper income taxpayers. This is because more lower income taxpayers are totally exempt from paying taxes.

As it stands, President Obama’s stimulus plan is likely to become law, but is doomed to almost certain failure as an economic recovery tool. Even though the president has only been in office a few days, he is rapidly approaching a defining moment in his presidency. By pursuing stimulus policies that have poor track record, he may very well be condemning the rest of his presidency to economic stagnation and creating another American Lost Decade.

Great Depression
Lost Decade
Tax Cuts


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