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April 21, 2009

Spending Won't Turn Economy Around this Year But Tax Cuts, Federal Frugality Just Might

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The idea that government "stimulus" spending can lift the United States out of recession seems straightforward. Government spends money, demand increases, the economy grows and the recession ends. Pretty simple! But this theory has one problem: it has never actually worked anywhere it has been tried.

During the 1930s, New Deal lawmakers doubled federal spending -- and unemployment remained above 20 percent until World War II.

More recently, Japan responded to a 1990 recession by passing 10 "stimulus" bills over eight years. It amassed the largest national debt in the industrialized world ... and their economy remained stagnant.

In early 2008, President George W. Bush signed a $168 billion stimulus bill, and the economy continued its freefall.

What's going on? Why isn't government spending increasing demand and economic growth? Because the spending theory contains a huge logical hole: It never asks where the money comes from. Congress doesn't have a vault of money waiting to be distributed. Therefore, every dollar Congress "injects" into the economy must first be taxed or borrowed out of the economy. No new demand is created. It's merely redistributed from one group of people to another.

Spending advocates respond that redistributing money from "savers" to "spenders" will lead to additional spending. That assumes that savers store their savings 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, or more recently, invest it in Treasury bills. Therefore, the money is spent by someone whether it is initially consumed or saved.

Governments, after all, cannot create new demand out of thin air -- as you can see in these examples:

  • If Congress funds new spending with taxes, it simply redistributes existing income.
  • If Congress instead borrows the money from American investors, those investors have that much less to invest or to spend in the private economy.
  • If Congress borrows the money from foreigners, the balance of payments adjusts by equally reducing net exports, leaving net spending unchanged.

Every dollar Congress spends must first come from somewhere. So in the recent "stimulus" bill, Congress merely transferred $800 billion from one group of people to another -- and then told us we're all wealthier for it.

Take highway spending. Lawmakers tell us every $1 billion in highway "stimulus" spending creates 34,779 new construction jobs. But Congress must first borrow that $1 billion out of the private economy, which then has $1 billion less to spend supporting jobs. It is a zero-sum transfer of jobs and income from one part of the economy to another.

Government spending remains popular because people can see the new jobs it funds. They don't see the jobs lost in the part of the economy that paid for it.

But consider this: If government spending could guarantee economic growth, then why stop at $800 billion? Why not borrow and spend $800 trillion? Shouldn't big government countries like France and Germany be the wealthiest in the world? And shouldn't Bush's spending spree have brought economic nirvana? In reality, the recent $800 billion stimulus bill weakens the economy.

It takes spending power away from families and entrepreneurs and puts it in the hands of politicians and bureaucrats. It will raise interest rates, therefore lengthening the recession. And worst of all, it dumped $9,400 per household of new debt into the laps of our children and grandchildren.

There is a better way: Reduce government spending and tax rates, and trust the people to spend their money more efficiently than politicians and bureaucrats would. Unlike government spending, this approach actually works. In the early 1980s, it turned the worst recession in 40 years into the greatest boom.

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 Plain Dealer (Cleveland)

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