The first order of business for the President-elect and the new
Congress is to get the American economy back on track. To that end,
Democratic and Republican leaders are busily crafting an economic
stimulus bill that will likely spend anywhere between $700 billion
and $1 trillion. But this unprecedented action--which would be
equivalent to one-fourth to one-third of last year's entire federal
budget--could do more harm than good if it is not well crafted.
The ultimate test for distinguishing a good stimulus idea from a
bad one is this: Is the proposal likely to raise the economy to a
sustained, higher level of growth, or will it slow or stall the
economy? This guide outlines several dos and don'ts to help
separate good stimulative ideas from the bad.
DOs: How to Stimulate the Economy the
Make the tax cuts permanent. The 2001 and 2003 tax cuts
were designed to increase market incentives to work, save, and
invest, thus creating jobs and increasing economic growth--and they
worked. In the six quarters after the 2003 cuts were enacted, the
economy grew 2.4 percent more than it had in the previous six
quarters, the S&P 500 increased by 32 percent, and over the
next 13 quarters 5.3 million jobs were created. If the cuts were
extended, projects, new businesses, and expansions of existing
businesses would be undertaken that would stimulate economic
activity today and in the future.
Lower corporate tax rates and accelerate tax
depreciation. The U.S. tax rate on corporate profits is the
second highest in the world. Cutting corporate rates to a level
below the average of other industrialized countries would enhance
our competitive standing and significantly reduce the incentives
for U.S. firms to relocate to lower-tax countries. Accelerating the
tax depreciation of capital equipment and buildings or the one-year
expensing of business purchases (which would otherwise be
depreciated over a longer period of time for tax purposes) can also
help during periods of slow growth.
Expand domestic energy supplies. Rapidly
increasing prices for gasoline and petroleum-based energy slowed
the economy and helped bring about our current recession, but
expanding domestic energy supplies could help reverse that trend.
The Heritage Foundation's Center for Data Analysis found that an
increase of 2 million barrels of domestically produced petroleum
per day would expand the nation's output--as measured by the gross
domestic product--by $164 billion and increase employment by
270,000 jobs annually.
Reform long-term entitlement spending. Our
short-term fiscal strength is threatened by enormous long-term
financial challenges caused by entitlement programs. Many investors
and organizations that play key roles in the future of the U.S.
economy are worried about long-term growth given the fiscal
challenges posed by Social Security and Medicare, yet Congress
seems unwilling to act. To begin to address these challenges,
Congress should amend the budget process to include a rule
requiring that the long-term obligations of these programs are
shown in the annual budget, and it should convert retirement
entitlements into 30-year budgeted discretionary programs to
contain long-term spending.
DON'Ts: Stimulus Ideas That Would Make
the Economy Worse
Spend public money in hopes of driving growth.
Economic growth--the act of producing more goods and services--can
be accomplished only by making American workers more productive.
Productivity is driven by individuals and entrepreneurs operating
in free markets, not by Washington spending and regulations. The
U.S. economy has soared highest when the federal government was
shrinking, and it has stagnated at times of government expansion.
This experience has been paralleled in Europe, where government
expansions have been followed by economic decline. A strong private
sector provides the nation with strong economic growth and benefits
for all Americans.
Use rebates to "inject" money into the economy in an effort
to increase demand. Supporters of rebates argue that they
"inject" new money into the economy, increasing demand and
therefore production. But every dollar that government rebates
"inject" into the economy must first be taxed or borrowed out of
the economy. No new spending power is created. For instance, in
2001 Washington borrowed billions from the capital markets and then
mailed it to Americans in the form of $600 checks. Rather than
encourage income creation, Congress merely transferred existing
income from investors to consumers. Predictably, the following
quarter saw consumer spending growth surge by almost 6 percent, but
it then dropped by nearly 23 percent. The overall economy grew at a
meager 1.6 percent that quarter and remained stagnant through 2001
and much of 2002.An effective fiscal stimulus means cutting
tax rates--not because of the resulting higher deficits but because
tax rate cuts improve the incentives for workers, investors, and
producers to do more, thus stimulating the economy.
Try to create jobs with frivolous transportation
spending. Studies by the Congressional Research Service,
the Government Accountability Office, and the Congressional Budget
Office have concluded that the impact of transportation spending on
jobs would be much less than anticipated--in fact, highway
construction could even have a negative impact on the economy. Lost
in the job-creation debate is the fact that the federal
transportation program is supposed to be about transportation,
mobility, congestion mitigation, and safety--not job creation. To
the extent that these goals are sacrificed to some illusive
job-creation process, the program becomes less effective, if not
irrelevant, and ought to be scrapped.
Implement non-stimulative tax cuts. To be sure, letting
Americans keep their money rather than sending it to Washington
means it is more likely to be used wisely. But if the additional
goal is to spur economic growth, any tax "jolt" will have little
impact if it means narrow tax breaks restricted to families who
engage in activities that Washington decides are worthy or checks
from Washington for the millions of Americans who are not even
paying income tax today. Short-term tax holidays will not rekindle
economic growth; only long-term reductions in marginal tax rates on
capital and work will accomplish that goal. Long-term tax rate
reductions--as opposed to short-term jolts--are needed because the
important economic decisions that will trigger a real recovery
depend on more investment.
Bail out states that mismanaged their own finances.
Congress is reportedly considering using stimulus funding to bail
out states dealing with their own budget shortfalls. This makes
little sense as a matter of economic policy. State spending does
not suddenly become stimulative because it is funded by Washington
instead of state governments. Increasing federal borrowing to keep
state taxes from rising is like running up a Visa card balance to
keep the Mastercard balance from rising. The overall costs do not
change; only the address receiving the payment does.
Fail to learn from the experience of other nations. History at home and
abroad demonstrates that strategies relying on increased spending
to stimulate the economy will inevitably fail. Indeed, such lessons
also suggest that such strategies make things worse by diverting
scarce resources away from productive use in the private sector.
For instance, in the 1990s, Japan rapidly increased government
spending in an effort to recover from its economic downturn, but
this led to slow growth, low industrial production, and a decline
in the overall standard of living.
Nicola Moore is a Research Coordinator for the Roe Institute
for Economic Policy Studies at the Heritage Foundation. This paper
is a compilation of excerpts from research by Heritage scholars
Brian M. Riedl, William W. Beach, J. D. Foster, Ph.D., Ronald D.
Utt, Ph.D., and Stuart M. Butler, Ph.D.
Riedl, "Why Tax Rate Reductions Are More Stimulative Than
Riedl, "Why Government Spending Does Not Stimulate Economic
Riedl, "Why Government Spending Does Not Stimulate Economic