Why Spending Stimulus Plans Fail

COMMENTARY Budget and Spending

Why Spending Stimulus Plans Fail

Nov 19th, 2008 3 min read

Senior Research Fellow

Brian Riedl is The Heritage Foundation's lead budget analyst and has built...

Congressional Democrats are now demanding another economic stimulus package to "inject" as much as $300 billion into the economy. The package will fail -- just like last year's $333 billion in emergency spending and $150 billion in tax rebates failed. There's a simple reason why.

Government stimulus bills are based on the idea that feeding new money into the economy will increase demand, and thus production. But where does government get this money? Congress doesn't have its own stash. Every dollar it injects into the economy must first be taxed or borrowed out of the economy. No new spending power is created. It's merely redistributed from one group of people to another.

Of course, advocates of stimulus respond that redistributing money from "savers" to "spenders" will lead to additional spending. That assumes that savers store spare cash in their mattresses, thereby removing it from the economy. In reality, nearly all Americans either invest their savings (where it finances business investment) or deposit it in banks (which quickly lend it to others to spend). The money gets spent whether it is initially consumed or saved.

Governments don't create new purchasing power out of thin air. If Congress funds new spending with taxes, it is redistributing existing income. If the money is borrowed from American investors, those investors will have that much less to invest or to spend in the private economy. If the money is borrowed from foreigners, the balance of payments must still balance. That means reducing net exports through exchange-rate adjustments, thereby leaving net spending on the economy unchanged.

Yet Congress will soon borrow $300 billion from one group of people and then give it to another group of people and tell us we're all wealthier for it.

Lawmakers commit this fallacy repeatedly. They tout unemployment and food-stamp spending as stimulus without asking where the programs' funding comes from. They hype a federal bailout of the states as stimulus, as if having Congress do the taxing and borrowing instead of state governments makes it a free lunch.

And, especially in this era, when "our crumbling infrastructure" seems to have become the new mantra, legislators and lobbyists tout a 2002 Department of Transportation (DOT) study that they believe proves that every $1 billion spent on highways adds 47,576 new jobs to the economy.

The problem is that the study doesn't actually make that claim. It stated that spending $1 billion on highways would require 47,576 workers (or more precisely, would require 26,524 workers, who then spend their income elsewhere, supporting an additional 21,052 workers). But before the government can spend $1 billion hiring road builders and purchasing asphalt, it must first tax or borrow $1 billion from other sectors of the economy, which then lose a similar number of jobs.

In other words, highway spending merely transfers jobs and income from one part of the economy to another. As economist Ronald Utt has explained, "The only way that $1 billion of new highway spending can create 47,576 new jobs is if the $1 billion appears out of nowhere as if it were manna from heaven."

The DOT tried to correct this misperception in an April 2008 memo specifying that their analysis refers to "jobs supported by highway investments, not jobs created" (italics in the original). The Government Accountability Office and Congressional Research Service also released studies making the same point.

In reality, economic growth -- the act of producing more goods and services -- can be accomplished only by making American workers more productive. Productivity growth requires a motivated and educated workforce, sufficient levels of capital equipment and technology, a solid infrastructure, and a legal system and rule of law sufficient to enforce contracts.

The best measure of a policy's impact on economic growth is through productivity rates. Lower marginal tax rates encourage working, saving and investment, all of which increase productivity (as opposed to tax rebates, which are grants that require no additional productive efforts). Reforming -- rather than merely throwing money at -- education and infrastructure will raise future productivity. These necessary improvements would take time and shouldn't be considered short-term "stimulus."

It's time for lawmakers to stop futilely trying to wave the magic wand of short-term "stimulus" spending, which threatens to push the deficit above $1 trillion. Focusing on productivity will build a stronger economy over the long run and leave America better prepared to handle future economic downturns.

Brian M. Riedl is Grover M. Hermann Fellow in Federal Budgetary Affairs in the Thomas A. Roe Institute for Economic Policy Studies at The Heritage Foundation.

First Appeared in The Wall Street Journal