Stimulus Agreement Means Lower Long-Run Growth

News reports indicate there is some sort of final deal on the so-called stimulus. Some of the politicians are acting as if this massive spending bill is “fiscally responsible” merely because the total amount of money is fractionally smaller than the House and Senate proposals. Ironically, as Veronique de Rugy explains for, even the Congressional Budget Office, which relies on a deeply-flawed Keynesian economic model, is warning that bigger government will hurt the economy’s long-run performance.

In a report to Sen. Judd Gregg (R-N.H.), the nonpartisan Congressional Budget Office (CBO) writes in plain English—well, economic language—that the Senate bill would eventually cause not a stimulus but a recession in “the longer run.” …On the CBO’s The Director’s Blog, Elmendorf explains why the Senate legislation would eventually reduce economic output:

The principal channel for this effect is that the legislation would result in an increase in government debt. To the extent that people hold their wealth in the form of government bonds rather than in a form that can be used to finance private investment, the increased government debt would tend to ‘crowd out’ private investment—thus reducing the stock of private capital and the long-term potential output of the economy.

The Senate might have done something straightforward, like cutting the corporate income tax or cutting the payroll tax that all workers pay. Instead, most of the provisions are tax credits, many of which are refundable. In other words, individuals and businesses need to pay their taxes up front and then will get money back from the government. These sorts of programs, aimed incentivizing investment, are better understood as spending programs disguised as “tax cuts.”

And here is one more thing to consider: There is absolutely no evidence that any stimulus package in the past 80 years has goosed economic activity—not FDR’s during the Great Depression, not Japan’s during the 1990s, and not George W. Bush’s in 2001 and 2008. If anything, the economic evidence suggests that such spending packages actually intensified and prolonged misery.

The Congressional Budget Office is right, albeit for reasons other than the ones generated by its garbage-in-garbage-out model. Bigger government hurts economic efficiency by diverting resources from the productive sector of the economy, and it does not matter whether government spending is financed by taxes or borrowing.