Posted in: Annual Report

Cash for a Clunker

By | September 17, 2010

“Today does not mark the end of our economic troubles. Nor does it constitute all of what we must do to turn our economy around. But it does mark the beginning of the end.” With these words in Feb. 2009, President Obama signed into law the American Recovery and Reinvestment Act, better known as the stimulus.

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In pure dollar terms, the $787 billion bill represents the single largest counter-recessionary effort in American history. With hundreds of billions of dollars in tax rebates, transfers to state and local governments, and direct federal spending, the stimulus appears a potent recovery package. Yet the effort has yielded mixed results. Despite the administration’s promise that it would keep unemployment under 8 percent, persistent layoffs have pushed the jobless rate near 10 percent—one point higher than the President’s prediction of today’s economy sans stimulus. Supporters contend that the recovery package prevented economic meltdown, yet the bill’s feeble results suggest otherwise. Its planners’ good intentions notwithstanding, ARRA suffers from structural deficiencies that keep it punching well below its budgetary weight.

The Unkindest Cut

Despite ARRA’s reputation as a gusher of spending, the largest component of the program is $288 billion worth of tax relief, largely in the form of a $400 per worker payroll tax credit for 2009 and 2010.  Unfortunately for ARRA’s designers, such one-time tax refunds are generally ineffective at inducing consumer spending. One University of Michigan study determined that beneficiaries of a similar provision in President Bush’s 2008 stimulus largely used the rebate to reduce their personal debt—helpful for consumer balance sheets but ineffective in generating the demand needed to stimulate the economy.

Economic theory suggests tax cuts are most effective when they permanently reduce rates, which generates expectations of higher future income. As J.D. Foster of the Heritage Foundation told the HPR, the ARRA rebate reduced people’s taxes without creating an incentive for increased consumer spending: just giving people checks “because they’re breathing,” he explained, does little to alter incentives.

Transfers for Fun and Profit

The largest segment of the bill’s actual outlays consists of transfer payments to state and local governments, for which it provided $144 billion, mostly during fiscal year 2009. While the federal government already subsidizes state budgets, having transferred roughly $500 billion to states in 2008, the stimulus created a new series of grant mechanisms, the most prominent of which is an $87 billion increase in the portion of Medicaid funded by the federal government.

The grants followed political and economic logic. Since constitutional mandates in every state except Vermont require a balanced budget, additional aid from the federal government, which can deficit spend, allows states to avoid raising taxes or cutting jobs. Either of these actions, as Harvard professor Theda Skocpol explained, would “negate a great deal of what the federal stimulus is meant to do.”

At first glance, ARRA appears to have proven relatively successful in preventing public sector layoffs. Only 231,000 state and local government jobs have been cut since Aug. 2008, a quarter to a fifth the rate of job losses in the private sector. While some of this disparity can be explained by the differing natures of the public and private sectors—governments rarely go bankrupt, for instance—the stimulus has likely helped.

Nonetheless, transfers have not proven a panacea. While ARRA will continue dispensing funds through 2012, most states have already reached the limits of their federal grants. Heritage’s Foster notes that the additional aid may have created a culture of dependency among state governments, noting that many “frittered the money and time away” while assuming the federal government would underwrite any budget shortfalls. Unless Congress approves President Obama’s June 2010 request for an additional $50 billion to prevent layoffs of state employees and strings along further fixes until the recession ends, or unless tax revenues magically increase, state and local payrolls will soon face the chopping block.

A Democrat’s Wishlist?

The remainder of the bill, some $350 billion, consists of federal direct expenditures on a series of programs. The funds appropriated range from an $11 billion earmark for an electrical “smart grid” to a $50 million grant for the National Cemetery Administration, with most of the spending going to smaller grants rather than multibillion-dollar “megaprojects.” Conservatives have unsurprisingly seen this category as proof that ARRA consists of political projects of dubious economic merit, decrying such stimulus-funded programs as a study paying subjects to smoke marijuana and drink malt liquor and a guardrail for a nonexistent lake.

Yet the meme of stimulus-as-pure-waste is likely overstated. Skocpol highlights appropriations for environmental weatherproofing, electronic recordkeeping in the health sector, and the wildly successful Race to the Top education reform among the bill’s positive legacies. Economists may debate the comparative efficiency of government versus private sector spending, but for those who believe in the former, many expenditures were likely worth the cost.

A more trenchant criticism lies in when the money will be spent. Because of the significant lag-time in project construction, somewhere between one third and one half of federal direct expenditures will occur in the years 2011 and 2012, when the economy will look quite different than it did when ARRA passed. The Center for American Progress’s Michael Ettlinger acknowledges a major goal of the stimulus was to “get the money out fast,” a test ARRA largely fails.

Lessons Learned?

Since its passage in early 2009, the vast majority of Americans have been critical of ARRA. A 2010 CNN poll found that 74 percent of Americans believe stimulus money “has been wasted,” and six in ten believe the bill consisted mostly of “projects that were included in the bill for purely political reasons and will have no economic impact.” Both numbers, the poll drily noted, stood much higher than the year before.

While concerns on the right that the stimulus has produced socialism are largely exaggerated, the apparent ineffectiveness of much of ARRA’s spending should put to rest assertions that it saved the economy single-handedly. Yet the fallout may cause future policymakers to seek the most politically safe—and least effective—means of fiscal stimulus. If so, ARRA’s greatest cost may be its legacy of ineffective temporary programs that do little to stimulate short-term growth.

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