Do Government Programs Grow the Economy?

While decades of increased government spending have resulted in economic stagnation, many advocates of increasing government spending claim that their favored program will "grow the economy." They argue that if government takes taxpayer money and "invests" it, that is the path to prosperity.

Think of the economy as a small lake. If you fill a bucket on one side of the lake, walk around to the other side (spilling some along the way), and pour the water back into the lake, you aren't increasing the total amount of water in the lake. But that is exactly how a lot of spending advocates argue government programs will grow our economy.

This argument ignores the basic fact that government has no money of its own, other than that which it takes from taxpayers. Claims that any program "creates" economic growth look only at the seen effect of government spending, not the unseen effect of taking that money out of the economy through higher taxes. How much better would families and businesses spend and invest their own money than politicians?

Economist Greg Mankiw looks at a couple of studies that estimate $1 of government spending will result in $1 to $1.40 in GDP growth. But he then points to evidence that $1 in lower taxes will grow the economy by $3:

By contrast, recent research by Christina Romer and David Romer looks at tax changes and concludes that the tax multiplier is about three: A dollar of tax cuts raises GDP by about three dollars.

In a Mercatus brief, Veronica du Rugy and Jakin Debnam ask "Does Government Spending Stimulate Economies?" Their review concludes that economists disagree widely on how much government spending effects the economy, but it appears higher taxes do more harm to the economy:

Some economists find spending multipliers that are smaller than 1.3 Other economists, however, assert that spending multipliers are much larger.4 Still others argue that multipliers can't even be credibly measured.5

... Barro and Redlick's research estimates that the multiplier for changes in defense spending that people think will be temporary - spending for the Iraq war for example - is between 0.4 and 0.5 at the time of the spending and between 0.6 and 0.7 over two years. If the change in defense spending becomes permanent, then these multipliers increase by 0.1 to 0.2.11 Over time, this is a maximum multiplier of 0.9. Thus even in the government's best-case spending scenario, all of the estimated multipliers are significantly less than one. This means greater government spending crowds out other components of GDP, particularly investment.

In addition, they calculate the impact on the economy if the government funds the spending with taxes. They find that the tax multiplier-the effect on GDP of an increase in taxes-is -1.1. This means that if the government raises taxes by $1, the economy will shrink by $1.1. When this tax multiplier is combined with the effects of the spending multiplier, the overall effect is negative. Barro and Redlick write that, "Since the tax multiplier is larger in magnitude than the spending multipliers, our estimates imply that GDP declines in response to higher defense spending and correspondingly higher tax revenue."12 Thus, they conclude that greater government spending financed by tax increases hurts the economy.

Finally, here is a great piece by Matt Mitchell on how economists disagree on the stimulus effects of government spending:

In a 2010 interview, future economic Nobel Laureate Thomas Sargent was asked about the economic advice given to President Obama about that same stimulus bill. He replied: "President Obama should have been told that there are respectable reasons for doubting that fiscal stimulus packages promote prosperity, and that there are serious economic researchers who remain unconvinced."

Indeed, there is quite a range of professional opinion. Reasonable economists, using valid techniques have found that $1.00 in government purchases can create as much $2 or $3 in new private sector economic activity. But, unfortunately, other, equally-reasonable economists using equally-valid techniques have estimated that $1.00 in government purchases crowd out or destroy as much as $3 or $4 in private sector economic activity.

Pennsylvania faces a four-alarm fire threatening our fiscal house. And the only way to fireproof the Pennsylvania economy is to control government spending, not take more from taxpayers.

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posted by Nathan Benefield | 02:27 PM

Federal Cash for State Budget Cuts?

MoneyIn an Investors Business Daily piece this summer, Nicole Gelinas puts forward an interesting idea about how to stimulate the economy, and at the same time cut back on future government growth. The idea is a reverse of President Obama's $4 billion dollar "Race to the Top" program, and other federal subsidy programs, which offer federal tax dollars to states for "innovative" reforms—but which almost always require higher spending by state government after federal funding goes away (case in point: expanding unemployment compensation eligibility).

In Gelinas' plan, federal money would be tied to reducing state and local government spending. For every two dollars states cut either now or in the future, states and cities would receive one dollar of stimulus money from the government. For example, if Harrisburg needs to make a debt payment now of $100 million, it could cut $200 million worth of future pension spending to receive $100 million in stimulus money.

Federal funding would be tied to things like moving to a 401(k) retirement plan for state workers, public employee wage freezes, or requiring government workers to contribute more for their health care.

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posted at 11:55 AM

The Downside to Government Spending

While federal stimulus funding for turtle tunnels, ant colony research, iPod Touch devices for students, and Blackberry smart phones for smokers might stimulate a few Americans, the rising national debt is bad for everyone.

Jeffrey Miron, Director of Undergraduate Studies at Harvard, explains how this federal spending spree is endangering the U.S. economy.

"The U.S. national debt currently stands at 62 percent of GDP, its highest level since WWII. Under plausible assumptions, this ratio will rise to at least 80 percent and possibly 185 percent of GDP by 2035 and continue increasing thereafter. As the debt-ratio increases, the U.S.'s creditors will demand higher and higher interest rates to continue financing this debt. This means ever larger deficits and ultimately a U.S. default. The U.S. can try to avoid this fate by raising taxes, but that approach faces both political and economic obstacles... If tax increases cannot restore fiscal balance, then the U.S. must slow the path of expenditure to avoid fiscal Armageddon."

To avoid the U.S. defaulting on loans in the future, the government either needs to drastically increase taxes, which slows economic growth, or drastically cut spending.

A recent Reuters/Ipsos poll shows that Americans want to cut the deficit, not increase spending.

  • 57% of Americans want the U.S. government to cut the deficit to stimulate the economy
  • 39% support deficit spending to stimulate the economy
  • 68% of registered voters think lowering taxes creates jobs
  • 60% think reducing the budget deficit creates jobs
  • 50% believe government spending creates jobs
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posted at 09:20 AM

Odd Headline of the Day

Stock Market

CNN reports, "Stocks rally to 4-month highs after economists report recession ended in June 2009." Three comments:

  1. Are you surprised to learn the recession ended 15 months ago?
  2. The recession ended before almost any of the Obama stimulus money had been spent, so that's not what ended the recession.
  3. Really? People bought stocks after learning a recession ended 15 months ago? As in previous instances, I'm not convinced reporters do a good job of analyzing stock market cause and effects.
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posted by Nathan Benefield | 06:13 PM

Stimulus 5.0

President Obama has proposed yet another round of stimulus spending. Of course, he won't call it a "stimulus," because of how unpopular that has become. Others are, erroneously, calling it a second or third stimulus -- but, at the least, it should be labeled Stimulus Number Five.

First there was the 2008 Bush stimulus, then the 2009 stimulus, the 2010 "jobs bill" and finally, the 2010 state aid bill.

Of course, this was on top of the 2008 financial bailouts, the run-up in spending under President Bush, and, here in Pennsylvania, Gov. Rendell's economic stimulus.

One would be hard pressed to suggest all of this has been great for job growth, or even to name a time when more spending stimulated the economy, but there are those who think Bush was an economic genius and Obama is wise to continue his legacy.

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posted by Nathan Benefield | 01:50 PM

The Imagined Effect of the Stimulus

Louis Woodhill writes on Real Clear Markets how the CBO's estimated impact of the stimulus is a fantasy.

In fact, the CBO readily admits it is simply plugging new spending numbers into the same model it used before the stimulus was enacted (HT Center for Fiscal Accountability):

CBO director Doug Elmendorf laid out the CBO's methodology pretty clearly, describing his office's frequent, legally-required stimulus reports as "repeating the same exercises we [already] did rather than an independent check on it." CBO tweaks its models on the input side, he says—adjusting, for example, how much money the government has spent. But the results the CBO reports—like the job creation figures—are simply a function of the inputs it records, not real-world counts.

To simplify, lets say the CBO model predicts that for every $1 million spent, 4 jobs are created or saved (the model itself is more complex than this, but yields a similar result).

That is, $800 billion = 2 million jobs or $600 billion = 1.5 million jobs.

Prior to the stimulus being enacted, the CBO estimates were based on how much money was expected to have been spent. The updates plug how much money was actually spent into the model.

Some will defend the model as sound, but it does not represent a measurement of the actual impact of the stimulus.

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posted by Nathan Benefield | 11:03 AM

Quote for the Day on Stimulus Spending

Yesterday, I tweeted Dan Mitchell's blog post, which in turn cited Richard Rahn's article on the evidence of "stimulus spending" vs. limited government on growing the economy. Mitchell has since responded to government-spending defenders - post one; post two - the second contains my "quote for the day."

Thompson also writes that, “Our unemployment picture is a little more complicated than ‘Oh my god, Obama is killing jobs by taking over the states’ Medicaid burden!’” Since I’m not aware of anybody who’s made that argument, I’m not sure how to respond. That being said, jobs will be killed by having Washington take over state Medicaid budgets. Such a move would lead to a net increase in the burden of government spending, and that additional spending would divert resources from the productive sector of the economy.

Snarky...and true.

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posted by Nathan Benefield | 03:30 PM

What Happens to PA Budget without FMAP Money

Gov. Rendell is supposed to meet with lawmakers today to discuss options if Congress doesn't approve the $850 million in federal FMAP funds.

Pete DeCoursey (subscription) breaks down the effect on welfare spending, which I try to summarize in fewer words, using a chart breaks down the spending.

Since 2008-09

With FMAP Funding


PA Welfare Spending Increase



State Sources



Federal Sources



(in millions)

The bottom line is, even if Pennsylvania does not get the federal Medicaid money, the cuts have to come from elsewhere. The state can't change eligibility and continue to receive stimulus funds, because of the "maintenance of effort" requirement.

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posted by Nathan Benefield | 09:47 AM

Rendell Requests Another Federal Bailout

Gov. Ed Rendell is at it again, lobbying the federal government for "Stimulus 4" (following the 2008 Bush stimulus, the 2009 Obama stimulus, and the 2010 "jobs bill") demanding another bailout of states with more Medicaid funds, education funds, and an extension on unemployment benefits.

Rendell encourages the federal government to once again reward states for spending more than their budgets allow, and give him money to spend without having to raise taxes or cut spending (though Pennsylvania taxpayers will still be on the hook for ballooning federal deficits). Pennsylvania's budget is not the only one relying on money - $850 million - to balance the 2010-11 fiscal year. Ohio, New York, Michigan, and California also dangerously bank on new federal funds that were only to be temporarily provided by the stimulus.

Governor Rendell claims that if federal bill HR 4213, extending higher Medicaid reimbursements through June 2011 is not passed, 20,000 Pennsylvania state workers will lose their jobs. Yet since the beginning of the recession, the private sector has lost more than 281,000 jobs, while Pennsylvania state government has grown by 5,000 jobs. How many of Rendell's "threatened" jobs have been added in the same period that private sector jobs have dropped considerably?

"Crucial" education money is included in this bill, also to be paid for by all American taxpayers. Pennsylvania could receive $900 million for education spending, ostensibly to keep 300,000 teachers employed. Sens. Casey and Specter are all on board with this bill, which has many obstacles in the Senate, and would move us ever closer to making the "stimulus" and bailouts for the states permanent.

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posted at 01:20 PM

Rendell: Democrats will Do Well if Voters Ignore the Policy Debate

The Wall Street Journal recently published an interview with Gov. Rendell that highlighted Rendell's analysis of policy issues - the stimulus, Wall Street/bailouts, and Immigration - at least in terms of how these can be used to help Democrats win elections. Rendell remains highly optimistic, at least in his rhetoric, that the Democratic Party will retain their majorities.

Stimulus: First, Rendell said that Obama's Stimulus Package will likely be an asset to Democrats, as long as they play their cards right. Rendell claimed that people are beginning to see that the stimulus package is not as bad as some were predicting, and touted that there have been gains in jobs in the recent months. He continues, Democrats need to make the case that "we're always the people who have gotten you the job."

However, unemployment rates rose after the stimulus plan was enacted. Few voters accept that unemployment rates higher than the Obama administration predicted would occur without the stimulus are a sign of success. Further, while most economists predicted, pre-stimulus, the economy would turn around in the 3rd quarter of 2009; Obama, Rendell, and supporter said the stimulus would lead to immediate recovery. Instead, the economic recovery was delay until early 2010 - hardly signifying the success of the stimulus. Indeed, Pennsylvania state budget shortfall is partly due to projecting a recovery that was delayed by the stimulus plan.

Immigration: Rendell claims that the Arizona immigration bill, or one like it in other states, will help Republicans in the short term, but in the long term offers decidedly Democratic gains, by pushing the Hispanic vote further into Democratic territory. It is true that the immigration bill will most likely be a strength for the Republicans - a Rasmussen poll recently found that 53% of Pennsylvanians support passage of a similar measure, and 71% support requiring police to check immigration status on traffic stops. Democrats may find political gains if they can convince citizens that this bill is based on racism or xenophobia, instead of as a response to drug war violence that has spread into Arizona. Apparently, discussing the facts of Arizona's law or the merits of such a state immigration law is too mundane than talking about how it affects the next political horse race.

Wall Street Bailouts: The article ends by Rendell attacking Republican Senate nominee Pat Toomey and Club for Growth for "connections to Wall Street." He blamed Wall Street as the reason voters lost their mortgages and 401(K)s, essentially causing of the recession.

Of course, Rendell is wrong on two counts. It was not "deregulation" or free markets that caused the financial crisis, but government intervention, including pushing Fannie Mae & Freddie Mac to increase subprime lending. Rendell also fails to mention that Wall Street money is flowing predominantly to Democrats, as Wall Street loves the faux "reform" and the permanent bailout solution.

If Rendell would subscribe to daily PolicyBlog email updates, perhaps he would better understand the policies he is pontificating about.

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posted by Nathan Benefield | 11:07 AM

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