Monty Brewster’s fiscal stimulus
In the 1902 novel “Brewster’s Millions“, the eponymous hero is challenged to spend every cent of his $1 million inherited fortune to win an even larger inheritance of $7 million. Brewster has a year to do it, and under the terms of the will he must obtain good value for the money.
Brewster’s struggle to spend $1 million, sensibly, in a year should serve as a warning for the problems the incoming Obama administration will face saving up to 2 million jobs within two years through the use of a massive fiscal stimulus package.
The exact size and scope of the fiscal stimulus remain unclear, but the transition team has indicated it will include substantial spending on infrastructure, singling out roads, bridges and school repairs.
Estimates vary, but the transition team has indicated it wants to make $25 billion available immediately for construction-related work.
Once tax credits and rate reductions are added in, proposals for the overall package have ranged from $200 billion to $500 billion, with outside analysts pushing for a half-trillion stimulus as the minimum needed to restore growth.
The challenge for the new administration is not the package’s size, but how to disburse the money fast enough.
The government is locked in a race against time. It needs to start spending the money before the massive round of layoffs, production cuts and retrenchment by businesses and households pushes the economy further into a prolonged and self-reinforcing slump.
But even for Washington, legendary for trying to fund the bridge to nowhere, it will be tough to find ways of delivering appropriate, labor-intensive and front-loaded spending that will put money into the hands of businesses and consumers quickly without too much waste.
SPENDING RATHER THAN TAX CUTS
Tax cuts or rebates could deliver money much faster. The Economic Stimulus Act of 2008 passed into law on Feb. 13, 2008. The first rebate checks were mailed out on April 28, and by the end of August 2008 the Treasury had issued 114 million individual payments totaling $93 billion.
The act provided a significant boost to household incomes and some increase in consumer spending over the summer, according to monthly estimates of income and expenditure published by the Bureau of Economic Analysis.
But most economists agree the rebates were not a very efficient way to generate spending increases. Consumer spending rose by much less than the implied rebate amounts over the summer months. A high proportion of the rebates were saved or used to pay down debt rather than spent on goods and services, diminishing the impact.
The effectiveness of any tax-driven stimulus would be even weaker in the current environment. Over-indebted households fearful about widespread job losses are far more likely to save and pay down debt than spend rebates on big-ticket consumer durables.
Direct spending by government rather than tax cuts is therefore probably the only way to mitigate the worst effects of the downturn. The problem is that spending faces long delays at the planning, budget and implementation stages.
It will take months or even years to identify a sufficient number of worthwhile, labor-intensive construction projects and develop new ones.
If spending is channeled through the regular budget process – starting with the president’s proposals and working through a congressional budget resolution, appropriations bills, project appraisals and competitive bidding for the work – contracts are unlikely to be awarded much before the end of 2009 or well into 2010.
Once the contracts are awarded, it could take months for project work to get underway, labor hired and paid. The U.S. Treasury’s Financial Management Service is unlikely to be asked to cut any checks within the next 18 months, and workers are unlikely to see any of the government’s money until the middle of 2010 at the earliest.
Spending would come far too late to forestall recession. In the worst case it might arrive once recovery was already underway, creating inflationary pressures in the medium term, saddling the government with a big debt in the process.
SUPPORTING STATE AND LOCAL GOVERNMENTS
The only quick and effective way to get federal money into the economy quickly is via payments to state and local governments to support and expand their own capital spending programs.
State and cities already have long lists of planned but unfunded capital projects ranging from school building to road maintenance and the construction of mass transit systems.
Not surprisingly, the prospect of a $200-500 billion pot of unallocated money searching for a home is attracting a host of bids like bees to honey.
The National Governors Association (NGA) has identified $37.5 billion of possible infrastructure spending on roads ($19 billion), transit systems ($8.0 billion) and other forms of transport. For the highways, it projects up to 3,000 projects could be under contract within 90 days, with 68 percent of the funds actually spent within two years.
NGA has also identified wastewater schemes ($9 billion), drinking water ($6 billion) and affordable housing ($5 billion) as recipients for federal support in what it terms a “federal-state partnership”.
Not to be outdone, the U.S. Conference of Mayors last week unveiled its own list of 11,000 “ready to go” projects representing investment of $73 billion and capable of producing almost 850,000 jobs in 2009 and 2010, according to its own estimates.
In some instances, the governors’ association and mayors’ conference have asked for a direct infusion of federal funds; in others for the lifting of matching requirements which require local jurisdictions to put up their own money to unlock federal grants.
But more important than the direct effect, channeling federal funding through state and local governments could mitigate the dangerous pro-cyclicality of fiscal policy at this level.
State and local tax bases are less diverse than at federal level and more vulnerable in the event of a downturn. The capacity to finance expenditure by borrowing is also much more constrained, especially at present, with state and local bond markets under pressure and the ability to issue short-term Tax Anticipation Notes (TANs) limited or foreclosed.
Making matters worse, most states have some form of “balanced budget” requirement that will ensure falling revenues are matched by spending cuts, at precisely the time when recovery requires more not less government spending.
State governors project a revenue shortfall of $60 billion in fiscal 2009 and $80 billion for fiscal 2010. Shortfalls will quickly exhaust reserve funds of just $70 billion.
Twenty states have cut $7.6 billion from their fiscal 2009 budgets according to NGA, and more cuts are expected.
The federal government is unlikely to make unconditional block grants or support current spending. But by funding capital projects, it could allow states and cities to divert more of their revenues to support current spending.
The result would be an increase in labor-intensive construction-related work on infrastructure (the sector hardest hit by the downturn so far), and fewer job losses in other areas of state and local activity such as education.
States and cities, rather than grand new federal programs, will probably be the prime engine of recovery.
For previous columns by John Kemp, click here.