Serious economists are nearly unanimous in their assessment that, in the current economic context, the most efficient methods for boosting employment is deficit-financed government spending (a.k.a., fiscal stimulus). Over the longer-term, increased spending on public investments (e.g., spending on infrastructure projects) will additionally yield considerable benefits to economic potential and employment. Yet little political capital is pushing the textbook case for more public investment or other spending to boost employment. Policymakers are instead looking to the tax code to “help grow the economy.”
Lately, tax expenditures (e.g., exclusions, deductions and credits, such as the mortgage interest deduction) have been getting some attention in political circles. But as I detail in my latest Fiscal Times column, the intent of eliminating tax expenditures to pay for lowering marginal tax rates is misplaced. If Congress were serious about using comprehensive tax reform to promote economic recovery and long-term growth, it would weigh tax expenditures’ opportunity costs without the presuppositions that government spending is anathema and beyond consideration for promoting job creation.
But of course the same is true of fiscal policy at large—the GOP’s policy agenda of haphazardly axing government spending in the hope that marginal tax rate cuts eventually follow is terrible economic policy for the vast majority of citizens.
The near-term impact of budget policies on the economy is characterized by the “fiscal multiplier,” or bang-per-buck. Multipliers depend on how quickly an increase in government spending will circulate through the economy, or how much of and how quickly a dollar of tax cuts will be spent instead of saved. Intuitively, direct purchases and policies targeted to low-savings or low-income households will have a much bigger impact on demand than policies targeted to businesses or households with a high propensity to save. Conservatives may dispute the magnitude of government spending multipliers, but neither magnitude nor the more important relative ranking is seriously debated among paid economic forecasters. And relative rankings suggest that well-targeted government spending currently generates about four to seven times as much demand as a dollar diverted to tax cuts for corporations or upper-income households (see the table in this blog post for relative multiplier rankings of a host of policy options).
Yet Congress has been ignoring basic economics in its rush to haphazardly cut government spending for the past two years. That cutting has resulted from conservatives leveraging threats of government shutdowns and sovereign default (the unprecedented act of hijacking the statutory debt ceiling), while simultaneously demanding the cost of any new policies be “offset” with more government spending cuts. Foisting austerity budgets on an economy desperately in need of increased government spending is entirely counterproductive and lacking credible academic justification. Sadly, the left won the intellectual debate over austerity, but lost the policy fight in Washington.
These budget cuts are additionally problematic because they are cutting important public investments in research, education, infrastructure, and public health, where they will take a heavy toll over the coming decade. As International Monetary Fund chief Christine Lagarde recently warned, sequestration is “absolutely inappropriate . . . because it blindly affects certain expenditures that are essential to support medium and long term growth.” By design this is true of sequestration—intentionally bad policy meant to force compromise on more sensible savings—but it also pertains to deeper, widely ignored discretionary spending cuts that started taking effect before sequestration.
The 112th Congress enacted roughly $3.6 trillion of deficit reduction (measured over a decade, assuming sequestration remains in effect). About 80 percent of that reduction came from spending cuts, almost entirely discretionary spending and with the greatest relative cuts coming from the non-security discretionary (NSD) budget. Over half the NSD budget is classified as public investment, and it comprises about 90 percent of all nondefense federal public investment. Both sides of the aisle talk a good game about public investment, but the money and proposed budgeting resources never meet the rhetoric (with the notable exception of the Congressional Progressive Caucus).
The trajectory set by the Budget Control Act (BCA) of 2011—the resolution to the debt ceiling crisis, which cut discretionary spending and sprung the automatic sequestration mechanism—has the NSD budget as a share of GDP being roughly halved within the decade relative to historical averages over the last half century.
Regrettably, the Obama administration, House Republican, and Senate Democrat budget proposals for fiscal 2014 all proposed federal nondefense public investment falling, within a decade, to the lowest relative levels since 1947.
Realistically, these funding levels are imprudent and inadequate. Public investment is a key driver of innovation and productivity growth. It demonstrates higher rates of return than most private capital, and it tends to encourage private investors to follow suit (a phenomenon that economists call “crowding–in.”)
While I completely agree that cutting corporate welfare (aka, inefficient tax expenditures aimed at businesses) is a tempting target, spending our political capital on such a project in order to cut top marginal tax rates is a poor return on our investment. Consider: A dollar of tax expenditures for businesses or upper-income households repurposed for cutting the top corporate tax rate or individual income tax rate would at best provide a small benefit (perhaps ten cents on the dollar) and could actually worsen near-term economic performance. And a dollar from well-targeted tax expenditures (e.g., the Earned Income Tax Credit) repurposed for cutting top marginal rates would likely reduce economic activity by roughly one dollar. A dollar of tax expenditures for businesses or upper-income households repurposed for direct public investment, on the other hand, will likely produce four times the near-term boost to jobs as will a dollar spent cutting top marginal rates, likely more.
But this tradeoff for near-term economic recovery broadly applies to sequestration and preceding discretionary spending cuts. Ideally, of course, we would simply repeal sequestration, restore the spending cut over the past several years, and finance the increased increase through deficits. That has been orthodox economic theory for 80 years. But in the event that deficit-financed fiscal stimulus cannot circumvent Congressional rules and norms regarding offsets, replacing enacted government spending cuts with progressively targeted revenue from businesses or upper-income households is the most cost-effective way to boost aggregate demand.
Under reasonable assumptions, replacing scheduled sequestration cuts with revenue from tax expenditures benefiting corporations or high-savings households would boost employment by at least 500,000 jobs in 2013 and 700,000 jobs in 2014, likely more. Replacing sequestration cuts with other contemporaneous spending cuts would provide no meaningful boost; conservative proposals to replace defense spending cuts with deeper nondefense cuts would worsen fiscal drags over the next several years.
Not coincidentally, this was our policy recommendation for navigating the “fiscal cliff” earlier this year. Instead, Congress largely left the problem unaddressed, with the not-unexpected result of backwards progress away from economic recovery this year.
Sequestration was never about fiscal responsibility, and a sane Congress would simply it repeal without offsets. But sanity has not been much in evidence in the 112th or the 113th Congress.
Barring a black swan midterm election result, offsetting revenue from base-broadening tax reform seems the only feasible way to increase public investment or finance any government spending to boost demand and employment. The most effective way for tax reform to advance economic recovery would be to pay for full repeal of sequestration and maybe begin restoring some of the austerity-driven cuts to public investment and the NSD budget.