Stimulus Requires More Than Taking Your Foot Off the Brakes

Last week I discussed how I think the President’s jobs proposal, the American Jobs Act, will be less than stimulating.  I updated it here.  I based my analysis on what economists call “back of the envelope” calculations – quick simple estimates of the key variables using rounded numbers.  Now the folks at Goldman Sachs research have put the proposal through their more sophisticated and complex econometric models.  And they come to … roughly the same conclusion.  Paul Krugman at the NY Times observes:

Goldman Sachs (no link) has a nice chart showing just how much fiscal policy has been a drag on the economy since the second half of last year, and also shows that the Obama jobs plan, even if enacted in full, would only be enough to put it in neutral:

Just worth bearing in mind.

The graph (the line) shows the effect that total government fiscal policy, including federal, state, and local, has had / will have on GDP growth rate.  In 2009, Q1-Q3, governments were having a very positive effect on GDP growth, adding up to 2.5 percentage points to the GDP growth rate.  By 2009 Q4, though, this stimulus effort had deteriorated and was starting to have a negative effect, slowing GDP.  Initially this was because state and local spending cuts were overwhelming the federal increases in spending.  But the 2009 stimulus bill ran it’s course and the feds joined the austerity party and started cutting spending along with state and locals in late 2010.  In 2011, our problems have been the austerity programs, the spending cuts at state, local, and federal level. Government has had it’s foot on the brakes trying to slow an already weak economy.  It’s worked. The economy is coming to a halt.

Unfortunately, the proposed jobs program isn’t really much of a stimulus. It’s too weak. It’s too small. And it’s focused too much on tax cuts that won’t be spent instead of spending.  The blue line above shows the likely effects.  Even if passed (a near impossibility given the Republican majority in the House), it will only reverse the contractionary effects of spending cuts without adding any new stimulus to grow GDP further.

Stimulus is supposed to be about speeding up GDP growth – hitting the accelerator.  Simply taking your foot of the brakes isn’t the same thing as hitting the gas.

 

Businesses (and Micro) Refute the Logic of Jobs Tax Credits

I wrote a few days ago about how I found the President’s American Jobs Act proposal to be less than stimulating and I updated my assessment yesterday.

Much of the proposal involves a lot of complex tax credit ideas that are supposed to provide the incentives for businesses to hire.  The idea is that if a $5000 or so tax credit is dangled in front of businesses, they’ll decide to part with some of the cash they are sitting on and hire.  It’s a dubious idea.  But it’s straight out of the conservative-thinking playbook. See this post for an explanation of the economic theories and thinking behind different types of jobs proposal. The conservative view and theories emphasive the supply-side. They posit that all can be fixed by providing greater financial incentives to businesses and that any form of tax is a disincentive.  The fact that President Obama has embraced these types of proposals is additional evidence, that contrary to the accusations that he’s a socialist or liberal, he is, in fact, quite conservative in his views.  He simply isn’t as conservative as the far-conservative/liberatarian wing of the Republican party would like.

There’s little historical evidence to suggest that tax credits for new hiring is a powerful incentive.  What I’ve always found interesting is that the economists and conservatives who propose these ideas claim that the theory underlying it is based on microeconomics – the idea that firms want to maximize profits.  But, in fact, it ignores basic microeconomic thinking about where profits come from.  Profits come from first selling something.  It makes no difference what your taxes are if you aren’t selling enough.  This is another reason why I think the idea of tax credits for new hiring will be a weak and relatively ineffective way of stimulating employment. It’s an expensive way to not get much results.  What really we need is an economy that spends more money.

To bolster my case, we can read about the reaction from many businesspeople in the New York Times:

The dismal state of the economy is the main reason many companies are reluctant to hire workers, and few executives are saying that President Obama’s jobs plan — while welcome — will change their minds any time soon.

That sentiment was echoed across numerous industries by executives in companies big and small on Friday….[M]any employers dismissed the notion that any particular tax break or incentive would be persuasive. Instead, they said they tended to hire more workers or expand when the economy improved.

Companies are focused on jittery consumer confidence, an unstable stock market, perceived obstacles to business expansion like government regulation and, above all, swings in demand for their products.

“You still need to have the business need to hire,” said Jeffery Braverman, owner of Nutsonline, an e-commerce company in Cranford, N.J., that sells nuts and dried fruit. While a $4,000 credit could offset the cost of the company’s lowest-cost health insurance plan, he said, it would not spur him to hire someone. “Business demand is what drives hiring,” he said.

On the other hand, creating lots of tax credits and tax code complexity will create some additional jobs and hours worked in one particular sector:  tax accountants and laywers.

UPDATE on President Obama’s Jobs Proposal – Better, But Still Weak

First an update on a post I made a few days ago. When I commented last Monday on President Obama’s jobs proposal, I was less than excited. Having read more detail of the proposal, I should correct some statements I made.  I incorrectly left the impression that the payroll tax (Social Security/Medicare tax) cut that the President was proposing was only an extension of the present year cut that is scheduled to expire December 31, 2011.

In fact, the President is proposing not only a 1 year extension of this year’s temporary payroll tax cut, but an increase in the size of that tax cut.  Estimates are that for a median household income of near $50,000, it would result in a $1,500 reduction in payroll taxes compared to not having any payroll tax cut at all. However, the existing, this-year only, payroll tax cut had already cut payroll taxes by up to $500 per household.  So of the claimed $1,500 tax cut for next year for the median household, $500 is an extension of this year’s situation and  $1000 is new stimulus.  Today’s economy is weak even with the existing temporary $500 tax cut, so extending that cut won’t improve things. It will only prevent things from deteriorating further.  In my world, simply agreeing to not put on the brakes is not the same thing as actually hitting the accelerator.

But, the proposal does contain perhaps $1000 worth of tax cut stimulus to nearly all working households. That’s perhaps $150 billion of pure, new stimulus to economy.  It’s more than I estimated on Monday, so the plan will likely have some more stimulative effects than I thought.  But how much?  Let’s do a quick “back of the envelope” type calculation.  The proposal puts $150 billion in consumers’ hands that wouldn’t have been there without it.  But for this money to generate jobs, people have to spend the money.  Simply saving the money or paying down debt won’t cut it.  That improves individual household balance sheets but it doesn’t cause any firm out there to go “oh, more business! I need to hire people!”  In normal times like the 1960’s or 1970’s people would have spent 85-90% of the tax cut.  But these aren’t normal times. We live in high debt, high debt payments, and scared-of-the-future times.  More people save in these kind of times. (paying down debt is economically the same as savings – think of your debt as a negative balance in a savings account).  Let’s assume that people spend 2/3 of the money.  Both history and theory indicate that people save more of a tax cut when they know it’s temporary, but let’s be generous/optimistic and say 2/3 gets spent.  That’s $100 billion in new spending.

Now when it gets spent, it generates business demand and jobs.  Those people get paid and then they go spend the money again – the circular flow of money in the economy.  How much?  That’s a huge controversy in empirical macroeconomics.  This is the question of what the spending multiplier is.  Estimates vary widely, although often the studies are heavily biased by ideology to begin with.  Let’s be modestly optimistic and say the multiplier is 1.5 – 2.0.  This is a relatively high estimate given recent studies as far as I know, but let’s run with it.  That means that after some months, this initial $150 billion in tax cuts becomes $100 billion in new, initial spending which ultimately increases total spending by $150-$200 billion.  Total spending is another way of saying GDP.  This puts it in the range of 1.0% to 1.5% of GDP.

There’s a rule of thumb about the relationship between changes in GDP to changes in unemployment rate. It’s called Okun’s Law.  It’s not a law so much as a statistical regularity. There are many versions, but let’s use a real simple one: each 2 percentage point change in GDP equates to a 1 percentage point change in the unemployment rate.  So if we have GDP growth increasing by 1.5% points, we can count on unemployment rate going down by 0.75 to 1.0% points.

We’re currently over 9% unemployment rate and stuck there.  I’m not real excited about a proposal that aims to reduce the unemployment rate from over 9% to maybe 8%.  We know 4-5% unemployment is possible.  We did it in 2006 even with the slow-growth policies of the Bush administration.  We did better than that under Clinton. In the 1960’s we were even below 4%.   Why are we settling for tepid responses and setting goals of only getting to 8% unemployment and then calling this “bold”?  I don’t know.  But then maybe I’m just a grumpy old man.

The Obama Jobs Proposal Is Less Than Stimulating

After over a year of Presidential and Congressional debate and sparring about how to reduce spending, cut deficits, and limit debts, the politicians in Washington have finally taken notice that we have a “jobs crisis”.  Specifically, we simply aren’t creating new employment fast enough to reduce our high levels of unemployment.

Timidity wrapped in strong words does not make boldness. The words on the teleprompter were bold and the President almost sounded passionate and concerned about jobs.  Unfortunately, in my opinion, this proposal is too timid. I see repeats of the errors of 2009 and the first stimulus bill, the ARRA.

First, let’s go over the details of the proposal.  The White House Fact Sheet is here. I’ll let Calculated Risk summarize the key parts for me:

1) Payroll tax cuts (approx $240 billion):

• Cutting payroll taxes in half for 160 million workers next year: The President’s plan will expand the payroll tax cut passed last year to cut workers payroll taxes in half in 2012 …
• Cutting the payroll tax in half for 98 percent of businesses: The President’s plan will cut in half the taxes paid by businesses on their first $5 million in payroll …

2) Schools and teachers / aid to states (approx $60 billion):

• Preventing up to 280,000 teacher layoffs, while keeping cops and firefighters on the job.
• Modernizing at least 35,000 public schools across the country,supporting new science labs, Internet-ready classrooms and renovations at schools across the country, in rural and urban areas.

3) Other infrastructure ($75 billion)

4) Extend unemployment insurance benefits ($49 billion).

5) Helping More Americans Refinance Mortgages (there are no details yet). “The President has instructed his economic team to work with Fannie Mae and Freddie Mac, their regulator the FHFA, major lenders and industry leaders to remove the barriers that exist in the current refinancing program (HARP) to help more borrowers benefit from today’s historically low interest rates.”

In total the whole package is estimated as a near $447 billion package of tax cuts and spending.  That sounds like a lot. And at first comparison it seems like a lot. The 2009 ARRA “stimulus” bill was approx. $780 billion spread out over 2.5 years. This “American Jobs Act” is supposed to be only a one year deal (part of the problem, by the way), so it sounds like it’s more in one year than the 2009 stimulus bill was.  But it’s not really.

For any government action, be it increased spending, tax cuts, or regulatory reform, to be a stimulus effect, it must provide a net change beyond what is currently happening.  That’s a major reason why this proposal fails as a stimulus.  Over half of the proposal, the $240 billion in payroll tax cuts provides no new stimulus beyond what’s happening this year already.  These payroll tax cuts, which should be called  cuts in funding for Social Security and Medicare, aren’t really a tax cut from what’s happening now.  It’s a proposal to delay the return to higher rates.  Payroll taxes were already cut temporarily for one year at the beginning of this year as part of the deal with Congress to extend income tax cuts for the highest-income bracket folks.  But that was only supposed to be a one-year cut.  This proposal basically extends that cut for another year and postpones the return to normal tax rate for another 12 months.  If these payroll tax reductions were enough to put people back to work in large numbers we would have seen it happen already.  We haven’t.  Deciding to delay applying the brakes as you had planned is a good thing, but it hardly qualifies in my book as hitting the accelerator.

In a similar fashion, the $60 billion in aid to states & local governments to help prevent teacher, police, and firefighter layoffs is a good and positive measure.  But it’s not really stimulus.  It’s a step that keeps the states and local governments from harming us further through their budget cuts.  I am concerned this only kicks the can down the road a little further, perhaps another 12-15 months, when state and local governments will repeat the layoff drive. Of course, if I were cynical, I’d observe that 12-15 months doesn’t really change the long-run growth picture for the U.S. but it’s enough to delay any second dip into recession until after the next presidential election.

We see the same dynamic in the extension of unemployment benefits.  Make no mistake, this is a seriously needed action for both economic and moral reasons.  But it won’t have a lot of stimulus bang – certainly less than the $49 billion sounds like.  That’s because it’s basically restoring the existing unemployment benefits that are expiring for the long-term unemployed.  Thus it will help prop up existing aggregate demand, but it’s not likely to deliver much new stimulus punch.

Part of the $60 billion  for schools and teachers (the White House doesn’t split it out) is aimed at infrastructure re-building for schools.  My estimate is that maybe it’s half of the $60 billion, or $30 billion.  That portion, along with the $75 billion in other infrastructure spending constitutes real stimulus.  It’s additional spending that will translate directly into new jobs. Those new jobs will then have a multiplier effect as these workers spend their money.  Unfortunately, both of these items together total maybe a little over $100 billion.  Even with estimates of spending multipliers on the high side at 2 or 3, it means a boost of maybe $200-300 billion in GDP.  But we’re in a more than trillion dollar hole of lost GDP potential.  So, yes, there’s some stimulus here, but it’s far too little.  Just like the 2009 stimulus bill was too small and too slow.

There are of course, some other items in the proposal.  I don’t see them having any effect.  There are proposals for some tax credits for small businesses to hire some businesses.  I don’t see that working.  Businesses hire because they are selling things, not because they can get a $5,000 tax credit.  There’s simply not enough aggregate demand for businesses to hire.  There’s also a pitch about helping Americans “refinance mortages”.  They tried this in 2009 and the program has been a miserable failure with very few refinancings done.  The incentives simply are wrong for the banks.  The proposal lacks specifics other than the President will “urge” agencies to do more.  I am skeptical.

So overall, I am disappointed.  Much of this stimulus proposal amounts to agreeing to delay the current contractionary policies.  That’s not the same as stimulus.   Too little. Too late.  And let’s remember, there’s not much chance that this Republican House of Representatives will pass much, if any, of this proposal.