Is the Prospect of Economic Stimulus De-Stimulating?

Sunday’s front page story in the Washington Post mentions the skepticism many policymakers and economists–even those from the President-elect’s own party–have about the effectiveness of some of the pieces of the Obama “recovery and reinvestment” plan (they no longer want to call it just “stimulus”):

Obama’s speech came as members of Congress, particularly Democrats, had begun attacking some aspects of the still-unfinished proposal. Sen. John F. Kerry (Mass.) and other Democrats object to a proposed $3,000 tax credit to corporations for each job they create or save, saying the credit would be ripe for abuse and difficult to administer.

John Irons (of the Economic Policy Institute) and I expressed similar doubts about that “new-jobs” business tax credit in an interview with Minnesota Public Radio last week (listen here), and Len Burman and Howard Gleckman have been testifying against it on the Tax Policy Center’s TaxVox blog.

And even the Obama economic team admits in their analysis of their own recovery plan (and here’s a video explanation by CEA Chair Christina Romer) that tax cuts are generally less effective as quick-acting stimulus than direct government spending is–even as they make an assumption in the analysis that overstates the economic bang per buck of the tax cuts (emphasis added):

These estimates show that all components of the program make important contributions to job creation. The direct spending programs have the largest job bang for the buck. State fiscal relief also has important direct and indirect effects on jobs, and so very strong job bang for the buck. Tax cuts, though they have no direct jobs effect and generally affect consumer and firm spending only gradually, also have important job creation benefits by the end of the two-year window.

It is important to note that the jobs effects of temporary broad-based tax cuts would probably be considerably smaller. Large proportions of temporary tax cuts are saved, blunting their stimulatory impact on output and employment. The prototypical recovery package only provides for the first two years of the Making Work Pay tax cut. Our analysis assumes that households treat the tax cut as permanent in determining their short-run spending.

But I really think Bruce Bartlett may have a legitimate new worry about why the “new jobs” tax credit, and all the talk of it being in the works, may turn out to be even counterproductive. In a column for Forbes, Bruce writes (emphasis added):

Unfortunately, Obama also plans another tax scheme with a very dubious record: a $3,000 tax credit for businesses for each new job created.

A similar program was enacted in 1978, but a report from the Department of Labor’s Inspector General during the Clinton Administration urged Congress to discontinue it because 92% of those hired under the program would have been hired anyway. An academic study found that 70% of the credits were payments for workers that would have been hired without them. Despite many efforts to reform the credit, it was eventually abolished in 2006.

In reality, it’s very difficult to determine what a “new” job is. And it’s hard to prevent businesses from gaming the system–laying off workers, rehiring them later and claiming a credit for job creation. Of course, the government will try as hard as it can to prevent this from happening, but in practice it is almost impossible to do. The primary beneficiaries will necessarily be firms that happen to be hiring for unrelated reasons.

In the near term, it’s possible that the prospect of a tax credit for employment will encourage businesses to lay off workers now and postpone hiring. No business wants to hire a worker and find out that if it had just waited a little bit longer to do so it would have saved $3,000 in taxes.

…and Bruce points out that this inverse “anticipation” effect of the policy may (unfortunately) occur with other parts of the Obama recovery plan as well:

Finally, the impact of increased public works spending on state and local governments cannot be ignored. Most federal transportation spending goes for projects initiated by them. When they think there is a chance that the federal government will increase its funding, they tend to cut back on their own spending in hopes that the feds will foot the bill. A study by economist Edward Gramlich found that the $2 billion appropriated by the Local Public Works Act of 1976 postponed $22 billion in total spending as state and local governments competed for federal funds and actually reduced GDP by $30 billion ($225 billion today).

There are reports that California and other states are halting highway, school and bridge construction already underway. While it may be that they are simply reacting to a shortfall in tax revenue, it would be naive to think that the prospect of stimulus spending from Washington isn’t a factor as well. As The New York Times recently reported, states “are clearly holding out hope that President-elect Barack Obama will pump some federal money into the stalled infrastructure projects, and some may even be delaying work until they have a chance to make the case for federal spending.”

Another somewhat-tangential worry I have about the recovery plan is what kind of jobs the recovery plan will create and who will get them. The Obama team wants to fill up a good part of the job loss hole that has already dug us 2.6 million jobs deep in 2008. Table 4 in their analysis shows they expect their recovery plan to create or save 3.675 million jobs over the next two years. While that would more than cover the total jobs we’ve already lost in 2008, the distribution by industry of jobs created does not line up with the distribution by industry of jobs lost.

The report shows 408,000 jobs to be created in the manufacturing sector, but 791,000 manufacturing jobs were already lost in 2008. It also shows 244,000 new jobs for the government sector, but 181,000 jobs were gained in the government sector in 2008. So the jobs created won’t exactly be a perfect replacement for the jobs lost (nor should they be if we want to do what makes sense from an economic efficiency and macroeconomic growth perspective), which suggests that for all this job creation to work smoothly, a good deal of attention will need to be on how to best match up the workers who have lost their jobs to the new jobs that are created. I wonder how much the Obama economic team has thought about that and how doing that right (such as providing for job retraining) may add to the cost of their plan.

Comments

[JohnAl:]

Here's my worry about the "recovery" plan: The money has to come from somewhere.

If it comes from taxes, that hurts the economy.
If it comes from borrowing from Americans, that's money that would have otherwise been saved or spent elsewhere, and that hurts the economy.
If it comes from borrowing from foreigners, those are dollars that otherwise would have been spent on exports or invested elsewhere in America, and that hurts the economy.
If it's just created out of thin air by the Fed, then each currently existing dollar will buy less, which hurts every holder of dollars, and thus the economy.

It doesn't take a doctorate in economics to figure out what this "recovery" plan really is.... it's politicians "doing something" because the idiotic electorate expects them to "do something" to "fix the economy".

In the end, all that will happen is that resources will be invested in areas where they would not have been had the plan never existed. In other words, all that's happening here is that people are letting the politicians decide what to do with their money.

Jan 13 05:42 AM

[John Lounsbury:]

If it is necessary to "restore confidence" in the financial system (and the economy), does that mean it is all a "confidence game"?

Jan 13 07:47 AM

[John Lounsbury:]

There is a serious dychotomy in the "stimulus" situation.

On one hand, it is widely agreed that action should be quick to have the most effect. Action delayed by six or twelve months is like having to rebuild a dike that could have merely been reinforced with action today.

On the other hand, the likelihood of mistaken action is increased if action is taken in haste.

This is all complicated by the opinion (again widely held) that this recession is likely to be much longer than other downturns since WW II. If that is the case, action is needed now which will have effects in 2010, 2011 and beyond. This is where the calls for establishing programs now which will encourage multi-year business activity. But many of these ideas will do nothing to help get things moving in 2009.

All the potential problems mentioned in the article are real. The list of complications is longer than the article discusses, and longer even than the combination of the additional factors in this comment with the article.

Jan 13 08:27 AM

[Danny Newton:]

The Broken Window Fallacy warns of creating jobs that are needed for the wrong reasons. The service life of the shop keepers window is cut short by a little boy throwing a rock at a window. The money spent on the glazier could have been spent on something that was needed by the family of the shop keeper. Infrastructure projects must be selected with care. Not all road projects are self sustaining or are able to pay for themselves without income transfers from excess funds earned from economically efficient roads. Dams and levees can cost so much, they are not worth the cost to construct them.

Jan 13 10:23 AM

[JohnL:]

All this talk of stimulus is curious. As a country, we've run up approximately $55 trillion in unfunded liabilities over the last generation or two. I would call that one very large, sustained stimulus package. Perhaps we should consider the notion that it was a stimulus package that got us into this mess.

Jan 13 11:52 AM

[OldLimey:]

Mr. Lounsbury: the answer to the question in your first comment is "yes" - take it from BB himself. Twice in today's speech at LSE he referred to credit market intervention being as much about generating confidence as providing liquidity. In fact, we could argue that we have interlinked crises afflicting the financial system and the wider economy: a credit crisis and a crisis of confidence.

Turning to the discussion above regarding tax credits for new-hires, the increasingly desperate UK government's approach is to hand out GBP2500 to firms that hire people who have been unemployed for at least 6 months. The SA audience is bright enough to work out the lunacies in this without any further explanation - although apparently our Great Leader isn't. My point is simply that the more that governments intervene in places they shouldn't be, the tighter the knot in their undergarments becomes.

Jan 13 02:07 PM

[derryl:]

Diane quotes,
"A similar program was enacted in 1978, but a report from the Department of Labor’s Inspector General during the Clinton Administration urged Congress to discontinue it because 92% of those hired under the program would have been hired anyway. An academic study found that 70% of the credits were payments for workers that would have been hired without them. Despite many efforts to reform the credit, it was eventually abolished in 2006."

I feel bad to admit it, but I cashed in on one of these 'job creation' programs in Alberta in about 1983. I spent about an hour filling out the application then hired one of the guys I was going to hire anyway and got a free $500/month from the government for about 6 months. It's immoral but times were tough and if the government insists on giving away money why should I not put my hand out?

About 20 years after I gamed this program I met a girl at a dinner who worked for the government administering similar programs. I told her that me and my business buddies joked about these programs, but she insisted very sincerely that the programs 'work'.

A few thousand dollars of free government money is not going to affect a business' hiring decisions, except maybe by delaying hiring until the program kicks in as Diane notes, or laying off then rehiring. Of course anyone applying for the money will assure the administrator that the program is 'essential' to the hiring decision. But if the job is really so marginally productive that it requires a $3000 subsidy to make it a viable hire, the job will almost certainly evaporate as soon as the subsidy expires.

I'm not saying Obama shouldn't do it just because it won't create new jobs like we're told it will. I spent my $500/month, so if the intention is to put spendable money in people's pockets this is one way of doing it.

Jan 13 08:34 PM