Five Borough Report June 2003
Supplement
How to Deal with
the Economy Today - and How Not To
Joseph E. Stiglitz
Columbia
University, 2001 Nobel Prize Winner in Economics
"Seldom have so few gotten so much from so many."
That might be the motto of President Bush's proposed tax cuts.
Bush's Mistake
As the nation entered the new millennium, it faced three problems.
First, the economy was slowly going into a recession, with a stock market
bubble about to burst. Second, inequality was growing. While the Nineties
had at last arrested the decline in income of those at the bottom of the
income distribution, the fruits of that decade's growth went
disproportionately to the rich. Third, there were long-range problems,
including Medicare and Social Security systems, that were underfunded and an
economy that had become addicted to living beyond its means, borrowing more
than a billion dollars a day from abroad.
Clinton bequeathed to Bush large budget surpluses which might have
been used to shore up our Social Security and Medicare system, provide
badly needed new benefits like long-term care and prescription drugs, and
repair America's aging highways, bridges, and airports. Instead, he took
advantage of the economic downturn to push for a tax cut, but not one
designed to stimulate the economy --and it did not do so to any appreciable
degree. Two years later, the economy is still languishing. The cost of
Bush's mistake has been enormous. In 2001 alone, we had a gap of some 3
percent between the economy's potential and what it actually produced, which
translates into a loss of $300 billion. And because of this mismanagement
of national economic policy, it will be lower five, ten, twenty years from
now since some of the lost output would have been spent on investments that
would have enhanced productivity.
We now know that the tax cuts were ineffective in stimulating the
economy. The tax cuts were oversold as a stimulus; and now we know they
failed. In an astonishing feat of fiscal mismanagement, the Bush
administration managed to squander the surplus, converting it into a $2
trillion deficit.
How to Stimulate the Economy
We know how to create a powerful and effective tax stimulus. What is
needed is to give money through the tax system to those who will spend it
and spend it quickly: the unemployed, the cities and states that are
starving for funds, and lower-income workers. A strong stimulus would also
be an equitable stimulus: the money, by and large, goes to the poorest
Americans, those who have benefited least from the growth of the last
quarter century. Giving money to cities and states would prevent cutbacks
in educational and health expenditures which can hit the poor particularly
hard.
Basic economic analysis indicates that increased government
expenditures can indeed be stimulative, and, in fact, are often more
effective as stimulus measures than tax cuts. The Administration's position largely ignores the
central feature of a recession: lack of demand. In a recession, the primary
problem is that the nation's firms face a reduction in demand for their
products - not that they lack available workers, equipment, or anything
else needed to produce goods and services. Indiscriminately injecting cash
into such firms through tax breaks, without linking the tax breaks to new
business activity, would do little if anything to address the underlying
difficulty. Only when a
company faces renewed demand for its products will it end the process of
shedding workers and begin to create new jobs. As a result, the primary
objective of a stimulus package should be to spur spending on these
products.
States are suffering substantial fiscal stress as a result of the
recent economic slowdown. In all states except Vermont, some form of
balanced budget rule forces such counter-productive fiscal policies: When
the state enters a recession, revenue naturally falls and expenditures
rise. The balanced budget rules then force the state to reduce spending,
raise taxes, or some combination thereof, which is counter-productive since
it exacerbates the economic slowdown.
Economic analysis suggests, contrary to the statements of some
political figures, that tax increases would not in general be more harmful
to the economy than spending reductions. Indeed, in the short run (which is
the period of concern during a downturn), the adverse impact of a tax
increase on the economy may, if anything, be smaller than the adverse
impact of a spending reduction, because some of the tax increase would
result in reduced saving rather than reduced consumption. For example, if
taxes increase by $1, consumption may fall by 90 cents and saving may fall
by 10 cents. Since a tax increase does not reduce consumption on a
dollar-for-dollar basis, its negative impact on the economy is attenuated
in the short run. Some types of spending reductions, however, would reduce
demand in the economy on a dollar-for-dollar basis and therefore would be
more harmful to the economy than a tax increase.
The impact on the economy depends primarily on the propensity to
consume, that is, on how much of an additional dollar of income is spent
rather than saved, among those who receive the transfer payments or pay the
taxes. The more that the tax increases or transfer reductions are focused
on those with lower propensities to consume (that is, on those who spend
less and save more of each additional dollar of income), the less damage is
done to the weakened economy.
The least damaging approach in the short run involves tax increases
concentrated on higher-income families. Reductions in transfer payments to
lower-income families would generally be more harmful to the economy than
increases in taxes on higher-income families, since lower-income families
are more likely to spend any additional income than higher-income families.
Indeed, since the recipients of transfer payments typically spend virtually
their entire income, the negative impact of reductions in transfer payments
is likely to be nearly as great as a reduction in direct government
spending on goods and services.
It
is worth emphasizing that any state spending reductions or tax increases are counter-productive at
this time: they restrain the
economy at a time when it is already slowing. Given the existence of balanced budget rules at the
state level, some form of federal fiscal relief to states is therefore
warranted.
A Five-Point Stimulus Package that Would Work
First, we should extend the duration and magnitude of the benefits
we provide to our unemployed. The unemployed, in a situation like this, are
innocent victims. Most of the people being thrown out of work want to work,
but our economy is not providing them jobs. Why should they suffer because
of economic mismanagement? This is not only the fairest proposal, but also
the most effective. People who become unemployed cut back on their expenditures.
Giving them more money will directly increase expenditures.
Since our "safety net" is worse than that of most other
industrialized countries, we also need extensive improvements in health
care, food stamps, and other kinds of programs. For eight years, the most
important part of our safety net has been full employment: people who were
let go could get another job because we had such low unemployment. That is
not going to be the case for the next six months to a year and a half. That
part of our safety net has gone, and we need to put into place an
alternative one.
Second, we need a temporary investment tax credit or expensing,
something to stimulate investment. Making it temporary encourages people to
make the investment today, when the economy needs it and when our resources
are not fully utilized. In 1993 we designed an investment tax credit
revision that had a huge bang for the buck. It's called an incremental
investment tax credit, and I strongly support moving in that direction.
Third, we ought to have better backward averaging of taxes,
particularly corporate income taxes. This is one of the proposals being
discussed within the Administration. One reason why there has not been
better backward averaging in the past is tax avoidance; to avoid this
problem, it should be limited to those firms engaged in investment
activities. If these firms were allowed to have a significantly longer
backward averaging, that would help provide them with the funds to invest
more.
Fourth, we need a more extended program of revenue sharing with
state and localities. State and local expenditures are pro-cyclical: when
the economy goes into a downturn, states and localities typically cut back
on their expenditures. This not only weakens the vital public services that
are provided at the state and local levels, but also deepens the economic
downturn.
We could put money into the states and localities very quickly
through a revenue sharing program that would enable them to avoid the kinds
of cutbacks that would affect every part of society. It would be
particularly good to direct funds to areas of particular need, like
Medicaid and education. There are a whole host of vital needs that are
typically provided by state and local programs.
Fifth, there needs to be an increase in expenditure in high-return
areas. It is very clear that there are areas in the public sector that are
starved for funds and where returns are very high. For instance, the air
traffic control system is woefully inadequate; investments in that area would
yield very high returns. We have inner-city schools that are dilapidated;
kids cannot learn in the kind of environment some of them face. These are
areas in which programs are already underway but in which expenditures can
be increased.
-- Excerpted from "Bush's Tax
Plan: The Dangers", New York Review of Books, Mar. 13, 2003;
presentation at Center on Budget and Policy Priorities Press Conference,
October 12, 2001
June 2003
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