Policy Points: January 9, 2009

Policy Points: Sobering Jobless Data Highlight Need for Recovery Package to Focus On Hard-Hit Families and States

pdf of this policy point (3pp.)

Since a decline in overall demand is the main cause of rising unemployment and the weak economy, the economic recovery package should focus on putting money in the hands of people who will spend it quickly.  Most economists agree that two cost-effective ways to do this are by helping hard-pressed families, such as those with low incomes and those that have experienced layoffs, and helping states avert steep budget cuts and tax increases that would reduce overall demand.  In fact, these measures would do more to protect jobs and the economy than the business tax cuts and certain other measures that some in Congress are promoting as “job creators.”

These conclusions are widely shared among economists.  Mark Zandi, chief economist for Moody’s Economy.com and a former advisor to presidential candidate John McCain, endorsed them earlier this week, stating:  “To provide the largest bang for the buck, a well-designed stimulus plan should include a temporary increase in government spending. . . .  The most efficacious spending includes extending unemployment insurance benefits, expanding the food stamp program, and increasing aid to hard-pressed state and local governments.”[1]

  • Poor families are more likely than businesses or higher-income families to spend quickly any new income they receive.  The Congressional Budget Office has stated that “the efficacy of fiscal stimulus depends critically on households’ tendency to spend the income placed in their hands.”[2]  CBO has also stated, “Lower-income households are . . . more likely to be among those with the highest propensity to spend.  Therefore, policies aimed at lower-income households tend to have greater stimulative effects.”[3]

    The reason is simple.  Families that are having difficulty affording food, shelter, and other necessities will spend any new income they receive to cover those basic costs.  Higher-income families, in contrast, are likely to save more of any extra income.

    So are businesses.  As Goldman Sachs has stated, “companies don’t spend money just because it’s there to spend.  To justify outlays for new projects, the expected returns have to exceed the costs, and that usually requires growth in demand strong enough to put pressure on existing resources.”[4]  This is why a 2008 CBO analysis comparing different stimulus proposals put corporate tax cuts in the lowest category for cost-effectiveness.[5]
  • Food stamps and unemployment insurance are two of the most effective forms of stimulus.  The CBO analysis cited above put expanded food stamps and unemployment insurance in the highest category for cost-effectiveness as stimulus.  “Additional [food stamp] benefits are likely to be spent rapidly by recipients, who tend to be experiencing periods of economic difficulty,” CBO noted.

    As for unemployment insurance, then-CBO director Peter Orszag told Congress in 2007 that “research has shown that the unemployment insurance system is among the most effective dollar-for-dollar economic stabilizers that we have in terms of counterbalancing periods of economic weakness.”[6] Supporting spending by unemployed workers in hard-pressed communities helps prevent the spread of layoffs and loss of jobs in those communities.
  • But unemployment insurance reforms are needed.  Fewer than half of unemployed workers actually receive jobless benefits because the unemployment insurance program, designed in the 1930s, is seriously out of date in many states.  Most states, for example, require applicants to look for a full-time job, even if they are parents raising very young children and were working part-time before being laid off.  These laws — designed when most workers were married men who were the sole breadwinners for their family — particularly disadvantage women, who are much more likely to work part time than men.

    Congress is considering financial incentives to encourage more states to adopt reforms that would allow more part-time and other laid-off workers to qualify for benefits.  States that adopt the reforms would receive temporary federal funds to cover the cost of paying the associated benefits for several years, but there would be no ongoing cost to the federal government, because regular unemployment insurance benefits are fully state-funded.
  • Fiscal relief is also badly needed.  Prior to the recession, states not only balanced their budgets every year but also had built up the largest budget reserves in recent history.  (This refutes the claim by some that states’ budget problems reflect fiscal mismanagement.)  The recession has largely wiped out these reserves.  Already 30 states have had to cut services ranging from health care to education, and more than a dozen have raised revenues.

    As a result of the deepening recession, state deficits are likely to total $350 billion to $370 billion over the next 2½ years.  Without fiscal relief to close part of that gap, states will have to institute exceedingly deep budget cuts and tax and fee increases.  Both kinds of measures reduce overall demand:  tax increases leave consumers with less money to spend, and budget cuts reduce state payments to vendors, benefit recipients, and others, thereby taking money out of the economy.  These measures would undercut the stimulus Washington is trying to provide.
  • Loans are no substitute for fiscal relief.  A few policymakers support converting the fiscal relief to loans.  This would render it ineffective as stimulus.  Many states have legal barriers that explicitly prohibit them from borrowing funds to cover operating expenses.  Even states that could accept the loans would be reluctant to do so, since they cannot know when their budgets will recover sufficiently to begin repaying the loans.  In the last two recessions, most states’ fiscal problems continued two to three years after the economy hit bottom.

Funds for infrastructure projects that can be undertaken in the next couple of years constitute effective stimulus, as well.  Such infrastructure investments are appropriate measures to include in a recovery package.

End Notes:

[1] Mark Zandi, “The Economic Impact of a $750 Billion Fiscal Stimulus Package,” testimony before the House Democratic Steering and Policy Committee Forum, January 6, 2009.

[2] Congressional Budget Office, “Economic Stimulus:  Evaluating Proposed Changes in Tax Policy,” January 2002, http://www.cbo.gov/ftpdoc.cfm?index=3251&type=0.

[3] Congressional Budget Office, “Options for Responding to Short-Term Economic Weakness,” January 2008, http://www.cbo.gov/ftpdocs/89xx/doc8916/01-15-Econ_Stimulus.pdf.

[4] GS Weekly, September 21, 2007.

[5] CBO, 2008.

[6] “State of the U.S. Economy and Implications for the Federal Budget,” Hearing before the House Budget Committee, House of Representatives, December 5, 2007.

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The Center on Budget and Policy Priorities is a nonprofit, nonpartisan research organization and policy institute that conducts research and analysis on a range of government policies and programs. It is supported primarily by foundation grants.

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