December 19, 2008
Fiscal stimulus: the case for block grants
A few thoughts on how the federal government might best implement a fiscal stimulus.
The first goal I'd encourage us to keep in mind is preserving flexibility. The U.S. faces very daunting long-run challenges in terms of the federal deficit, and these could easily turn into a serious immediate problem if we were to see a sudden shift in foreign demand for U.S. assets. I would not want to see us begin "temporary" stimulus efforts which we lack the political will to undo once they're put in place.
Moreover, to be effective, quick action is called for. Grandiose new federal programs necessarily involve a long start-up process, which I do not believe we can afford.
The final core principle should be to prevent further economic damage. State and local governments are on the verge of implementing significant contractions in spending as they try to stay within their budgets. Unlike the federal government, state and local authorities often lack the flexibility for deficit spending.
For example, on Thursday the San Diego Union-Tribune reported:
Raising another alarm in California's budget crisis, a state panel that oversees loans for public works voted Wednesday to stop financing nearly all infrastructure projects in the state, halting nearly $4 billion in loans for everything from freeway interchanges and carpool lanes to classrooms.
Nor should we suppose that additional federal spending is the ideal response to a cut in state and local spending. If federal spending increases by the same amount that state and local spending decreases, it is not a pure wash as far as the economy is concerned. This is because there are multiplier consequences from local layoffs, and the resulting unemployed resources should not be assumed to costlessly relocate to wherever the new federal money might go. Better to keep the original person employed in the first place.
For these reasons, my preferred fiscal stimulus would take the form of temporary unrestricted block grants to state and local governments.
UPDATE: Mish has more on the situation in California.
Posted by James Hamilton at December 19, 2008 06:21 PMdigg this | reddit
I think the Obama people are already thinking along those lines, and it makes perfect sense. But as far as a positive stimulus goes, wouldn't that just decrease the number of state and local job losses going forward?
The same seems true for the infrastructure spending, it will keep public construction spending from falling, but it won't mitigate job losses in private construction.
Public construction spending in 2008 is already about 50% higher than five years ago. (In other words, the idea that there has been a dearth of infrastructure spending recently is a bit of a canard.)
So sending a $150B to states for infrastructure spending will mainly replace spending they would otherwise cut.
Likewise, sending the states $150B in unrestricted grants will lessen the blow from future government cuts.
But it isn't isn't going to create 2.5m jobs.
I think the states will need another couple hundred billion to keep their pension funds solvent. No jobs created there.
Posted by: Bob_in_MA at December 19, 2008 07:09 PM
I've convinced myself that fiscal stimulus is impossible right now (actually, I think I knew this when the crisis first became widely realized in Sept.) and that only economic stimulus will work. We spread money around, see where it goes (besides paying down principal) and invest increase the supply of the goods and services it seeks out. Like we should have done before we pumped money into houses and people invested in the resources to build them. Recently, besides debt, the money was all going into oil.
Posted by: aaron at December 19, 2008 07:14 PM
In the midst of the slow recovery from the 1990-91 US recession, Robert Solow and Francis Bator in "Two Ways to Wake Up the Economy" (The New York Times, December 4, 1991), made a similar argument in favor of such federal grants to states.
Posted by: Phil Rothman at December 19, 2008 10:01 PM
If you want to bail out California from its insane profligacy, feel free. Just know that we'll be back for more next year and the year after that and the year after that ...
Posted by: K T Cat at December 19, 2008 11:45 PM
Actually, since politically it would be necessary to dole out the money proportionately, you'd be giving a big chunk to states that are doing OK, say Texas. Might they not use the extra money to pay down debt, or essentially save it?
Posted by: Bob_in_MA at December 20, 2008 05:47 AM
While I like the principle of allowing states to decide how best to spend the money, there are some states that are more fiscally irresponsible than the Feds. I take it K T Cat is from such a state.
Posted by: Hitchhiker at December 20, 2008 09:40 AM
Block grants should be for true investments in infrastructure, things that need to be done, such as new highway construction, replacement of all the bridges we worried about after the I-35 collapse in Minneapolis, a new power grid. Just giving the states block grants as a blank check does not force them to make the tough choices. Every governor and mayor asking for infrastructure funds should sit in front of a televised committee, justify his requests, and expect to face ridicule over projects like a water park ride in Miami, a study of prostitution in Dayton, and the baseball museum in Durham, NC. Every foolish request should be explained by the fool proposing it. That is the only way these guys will learn.
There are a lot of sound, justifiable projects out there that have been languishing for years because of tight state budgets. We need to identify them, and apply unemployed human resources to get them done.
The smart money in the economics field has always said that WW 2 is what brought us out of the Depression. Think about putting America on a wartime footing, without the war. The objective is to complete projects that will put America on solid economic ground for the rest of the century. Projects similar to the Interstate Highway system are an example.
And if somebody wants to add a polar bear exhibit to their zoo, let them raise private money to do it.
Posted by: RandyMiller at December 20, 2008 02:58 PM
Hi JDH, I had suggested this idea an earlier thread. I would like your comments on it. It is a tax and spend policy with a twist.
Lets say the US government understands from standard macro-economic models that it needs a trillion dollars of stimulus to prop up employment back to proper levels.
Instead of cutting this amount from taxes or announcing spending programs of that amount, announce a Trillion dollar prize, which will be paid out at the end of lets say 3-4 years (a time by which one might reasonably say useful physical/social capital can be created).
The prize will be for creating jobs. To avoid an overload of minimum wage jobs, the prize could have a minimum cutoff wage or can be based on payroll amount instead of jobs created. To avoid concentration of high paid fat cats, the prize can be given based on the multiplicative product of all salaries. This way, orgs that pay out more equally do better.
In auctions or such game-theoritic situations, you will have multiple players trying to end up with one prize and in aggregate, losing out. But here, that is what we want. We want people to spend more than a trillion dollars trying to get to that pot of trillion and voila, we have money going into the hands of people.
The advantage this proposal has is that it is totally upto the organizations to decide how they want to structure their "jobs". All we are concerned with are salaries. No bureaucracies, no planning mistakes, no second guessing the market's "true wants".
Companies could set people out to do infrastructure work, to teach, to learn - anything. Plus since the focus will be on salaries, the companies will still try to be frugal on other costs, thus not igniting inflation.
Posted by: Anonymous at December 20, 2008 07:32 PM
the last post was from me.
Posted by: Prakash at December 20, 2008 07:35 PM
At least one naysayer is needed.
Any stimulus applied in the next 6 months will disappear down the rat hole of paying for mortgages that people cannot afford or paying for bets that people never should have taken, or at least, should not be able to use the U.S. courts to enforce (since they were legally excluded from regulation).
I say let the decline continue - as it is likely to do no matter what Obama does - at least, he will not have failed if he delays the start of his stimulus. After 6 months, the money is much more likely to be spent on new goods and services produced by the domestic economy (if imports can be restrained). There is a time for everything. The time for implementing a stimulus is not now.
Posted by: ReformerRay at December 20, 2008 07:43 PM
Once the cash is delivered, you have very little control over block grants. The common trick is to get a block grant for one thing, say roads and bridges, and then reduce your own budget for roads and bridgesw by the same amount and put that money into the general fund. The other trick is to redefine something else, perhaps the California Highway Patrol, as a roads and bridges team and draw their funds from the block grant.
All of this misses a much larger point. Roads and bridges represented a marvellous new capability in the 1930s and 1950s. Today, this money is at best a repair job for deferred maintenance. There is no ROI on this at all. The analogies with FDR and Eisenhower don't work.
Posted by: K T Cat at December 20, 2008 09:39 PM
Block Grants??? A Block Grant assumes that federal money passed to lesser governmental bodies is spent in the best interest of the citizens of that lesser governmental body.
I submit to you Exhibit A: The state of Illinois
Why not a Categorical Grant which imposes strict and detailed provisions on the way grants are to be spent?
Again, all of this talk (Block/Categorical Grant) assumes that the government bureaucrat (see what the the $286.4 billion Transportation Bill 08/2005 bought us) is more virtuous than the entrepreneur.
So, lets see... Government plans to spend the money of another (the taxpayer) on somebody else.
Why, if government is to spend the money of another (taxpayer money; my money) on somebody else, should I not be concerned about how efficiently that money is to be put to work? What is my recourse if that money is lost?
History shows us that if one spends the money of another on somebody else, the tendency is not to be concerned about how much money is spent and if that money is spent wisely.
To believe that the government bureaucrat would police himself/herself is quite a leap of faith.
Posted by: Babinich at December 21, 2008 04:37 AM
"The smart money in the economics field has always said that WW 2 is what brought us out of the Depression".
To get the economic benefits created by WW II, an economy would need all of the restraints on consumer spending that existed during the war. Inflation was held in check by ration cards. Does anyone want a return to rationing?
Pent up demand for all kinds of goods and services, especially housing, in the years immediately after the war allowed the U.S. to quickly return to production for domestic demand (savings were built up during the war because of the depression of the previous decade). The federal debt created by spending on guns and tanks was quickly erased by the combination of taxes and productive private sector.
Government spending without any idea how it will be repaid is not a good idea - despite the fear-driven current investment in Treasury certificates.
Posted by: ReformerRay at December 21, 2008 06:43 AM
There's ideology in the way of real economic stimulus. To ever come out of the recession, "induced demand" can't be a swear word. It's the whole point of stimulus, not a symptom.
Posted by: aaron at December 21, 2008 07:34 AM
Aaron, induced demand is only temporary. Once we've gone through the $1T, we will have ... what?
Borrowing and spending got us here. More borrowing and spending won't get us out.
Posted by: K T Cat at December 21, 2008 08:11 AM
JDH Your proposal makes excellent sense given the premise that the recession will be much deeper and longer than many commentators on your blog seems to think. Automatic fiscal stabilizers will have little opportunity to function if state and municipal governments conduct massive layoffs and expenditure cuts. Social services could potentially suffer during a period when needed most. New federal program spending will be vulnerable to wasteful domestic rent seeking, and the usual list of co-ordination problems.
I'd be curious to know of possible implementation details that would guard against adverse selection and moral hazard risks of recklessly rewarding fiscally imprudent behaviour in the immediate past and going forward.
In addition, the US could probably benefit from some kind of long-term visionary program that points the way forward. A program of northern European-level excise taxes on non-renewable fuel scheduled to come into effect over a decade-long period would be one such program. It promises benefits for the national debt, the balance of trade, per capita wealth levels, reduced pollution and green-house gases, health, socially richer cities, and enhanced national security.
However, it is not clear that sufficient numbers of individual Americans are willing to make sacrifices for the collective good, the pull of myopic possessive individualism is simply too strong. Perhaps it is time to finally say good bye to US hegemony of old and all the associated privileges?
Posted by: GNP at December 21, 2008 08:54 AM
Instead of grants, why not cut taxes, which increases ROI without distorting incentives. If you give grants, resources will not necessarily flow to their best use. You will have lobbyists and central planners making the decisions. I do think decisions at the state level are probably better than at the Fed level.
There was a good Op Ed in the WSJ the other day suggesting "Stimulus Shouldn't Be an Excuse for Pork"
Posted by: MikeR at December 21, 2008 02:53 PM
It is generally a good idea to at least recognize the goals of any project before offering criticism. There seems to be an implication in some of the comments here that the goal of any stimulus plan now should be the same as under FDR - or under Ike - that there should be an economic return beyond a sort of Keynesian multiplier effect of stimulating aggregate demand. That would be nice, but as aaron points out, the stimulus plan being cobbled together now is aimed at stimulating demand. Block grants may not be ideal at that, but they ain't bad, for the reasons our host notes.
I'm all in favor of spending efficiency, so getting as much for our money as possible is a great idea. Getting real, lasting benefits in terms of efficiency would be nice. So would getting a big spending multiplier. There may be a trade-off between the two. If so, we need to understand the trade off and take it into acount, but again, the primary goal of a stimulus package now is to stimulate demand.
As to the notion of using tax rather than spending policy as a stimulus, the problem is that the amount of activity generated in the short term is far less with the best tax cuts than with even mediocre spending. At the high end, estimates multipliers for spending programs are a substantial multiple of multipliers for tax cuts. That is as true for California as for Texas.
FDR instituted a screening process to keep grants to states from going to purposes that wouldn't do the things FDR wanted done. That could help keep spending projects within the bounds of a good economic stimulus.
By the way, when thinking about the value of repairing bridges rather than building them, we should look at the cost of not doing so. Not maintaining bridges means we eventually lose the bridge. Not having a bridge due to lack of repair has much the same economic consequence as not having the bridge at all. The return on repair is much higher than on construction, if the alternative in both cases is no bridge.
Posted by: kharris at December 22, 2008 06:58 AM
the stimulus plan being cobbled together now is aimed at stimulating demand
If that's the case, then why not just have $1T of tax rebates? It's trivial to administer and it spreads the wealth out much farther than roads and bridges. This is a consumer-driven economy. Consumers are maxxed out with debt. After we pave Kansas, Idaho and Wisconsin and sit back, exhausted and $1T more in debt, the consumer will still not spend because their balance sheets haven't changed significantly. Meanwhile, the lobbyists and contractors in DC will wax fat and prosperous.
I don't see any fundamental argument for this stimulus bill. To me, it's a bunch of numbskulls playing dress up, pretending they live in the 1930s.
Posted by: K T Cat at December 22, 2008 08:40 AM
It seems as if the housing crisis started the problem, then the solution should start there as well. Throwing money any where else is just throwing money to say look I am throwing money at something. My analogy is if a house is on fire, watering the neighbors lawn and flushing their rain gutters is throwing water around but it isn't helping to the problem at hand, the house fire.
As for a stimulus plan... Why not require banks (who where the ones handing out loans like they were tic-tacs) to sell the properties even if it is at a loss. Then the properties will be off the books and the banks can start fresh. Sure this will cause a lot of pain all the way around, banks lose money, homeowners lose money due to depreciation. The government should come in and help the current homeowners by paying the depreciation in value of their home towards their loan. This would help those who were innocent but make those who were guilty feel the pain. Yes some big banks will go under for their mistakes but conservative banks will be just fine. The government should provide an "orderly bankruptcy" of those misguided banks.
As for this recession here is my second analogy... Its like a lady who is pregnant and about to deliver, it may have been a lot of fun to get into the situation but getting out of it is going to be painful. It seems as if everyone is looking to the government for some sort of painkiller to make this easier. That is not what the government is for. Sure the government was asleep at the wheel and should have been telling the banks to use protection so they wouldn't get into this situation, but ultimately it was the banks who got themselves into it by not using any restraint.
The way to get people working again is to stimulate demand. The more products people demand the more workers that will be needed to produce those products. Going toward a green economy will stimulate demand and hence jobs in those areas. While we can argue all day about whether or not green is economically viable with $40 oil etc, we can say that taxing people who drive gasoline cars will stimulate green demand.
Posted by: me at December 22, 2008 08:40 AM
kharris, how can we know that government spending multipliers are larger than the multiplier from a tax cut? How can they possibly be measured when economics is a social science and we have to deal with time series data? We can not run controlled experiments. When ever people discuss multipliers, never give confidence intervals. I would bet that the confidence intervals for all multipliers overlap, meaning that they are statically indistinguishable.
I still think a tax cut has a bigger multiplier because of its effect on incentives while government spending crowds out investment demand. Certainly you would agree that the uncertaintly created by recent government intervention has caused more investors to sit on the sidelines. Who would invest in GM or Ford right now, knowing that the government is likely to intervene? I don’t understand why economists turn into central planners when the economy slows. Do centrally planned economies experience fewer or shorter recessions?
Posted by: MikeR at December 22, 2008 10:29 AM
Me, there are some problems with a gas tax. Even if it is revenue neutral, some inefficiencies need to be ironed out for it to be economically beneficial. The correlation of gas price with fuel efficiency has actually been negative the past several years. We're wasting more fuel than before, that's part of why the economy is down. People don't respond well to excessive penalties, just like excessive rewards. An extreme example is Learned Helplessness.
I plotted gasoline consumption, vehicle miles travelled, and price data here.
The correlation of gas prices and efficiency has gone negative. We see reductions in consumption due to forgone economic activity. We actually get less done with the same amount of fuel when gas prices go up, for several reasons.:
1.People are at their limit of how much driving they will tolerate. This means we get giffen behavior when gas prices increase. People spend more time driving for work, when thereï¿½s lotï¿½s of traffic, just to get ends to meet, and shift driving away from less congested times.
2. People have big misconceptions about what is efficient. Driving slower saves fuel, when youï¿½re driving above 55mph. Below 40mph, driving faster is more efficient. Accelerating faster is about the same, or slightly more efficient, than accelerating slowly. Typical car engines donï¿½t see efficiency drop off until after 3000rpms.
3. Tragedy of the commons. About the most fuel efficient behavior you could adopt is avoiding braking. However, if you do this during congestion, you prevent cars from clearing into your queue and create more bottlenecks. Starting from a stop is the big gas waster. A stop can take 6 times more fuel than a rolling stop.
4. Unfortunately, when times are lean (which happens when gas prices are high) people return to more conservative dress and traditional work hours to compete for jobs. This may lead to more congestion.
Gas demand is inelastic in the short term, but I think this is because it is the most basic input of economic activity. It takes a long time for the effects to ripple out to the point that prices rise and incomes fall and people stop working and investing.
Posted by: aaron at December 22, 2008 11:21 AM
Here is a plot of fuel efficiency and gasoline price from Jan 1998 to May 2008.
Posted by: aaron at December 22, 2008 11:44 AM
In the discussions over fiscal stimulus, I see precious little account taken of the reponse of the external balance. This response is important for the short-run effectiveness, and for the long-run consequences. For example, if the stimulus is funded primarily from external borrowing, we will be in for some truly bad results.
The employment multiplier for spending on state and local government services is higher than just about any other type of spending. This and my fear over how Reid and Pelossi would spend the money cause me to second JDH's conclusions.
Posted by: don at December 22, 2008 12:09 PM
JDH, looks like you would trade speed for unintended consequences. Lets assume that "temporary unrestricted block grants to state and local governments" really is temporary. I doubt that temporary will stay that way. There is a long record of Federal temporary money turning into permanent money flows to states. With free Federal money, state and local govt have no incentive to change. Most of the new money would go into schools and health care payments -where most of the money goes today. Though both are essential services, neither are well managed to deliver top performance. The US spends a lot on both and ranks moderate to low on results versus other countries. If we are to fix the performance problems, creative new management is needed. Unfortunately, creative management seldom happens when funding is plenty, rather it happens as a response to problems. Unfortunate, but true. So block grants fund jobs in a couple sectors, and do not stimulate creative problem solving in governments. With the private sector going through intense pain and the necessary changes to fix problems, why should local and state governments remain fat, dumb, and happy? And the private sector gets little to no stimulus in this proposal. Not a winner in my book.
Posted by: Mike Laird at December 22, 2008 02:58 PM
I sent an e-mail to the Obama transition which recommended a large portion of the stimulus, nearly $2750 per tax payer be included in the tax returns this late winter early spring. No additional cost to cut checks no politicians deciding whick bank or business gets the coin. If we really want instant demand to take hold this is the surest and purest form. Give the taxpayers back their money and let the invisible hand take hold. Questions?
Posted by: Steve at December 23, 2008 08:55 AM
On taxing gasoline, see The 26 December 2008 editorial in The New York Times entitled: The Gas Tax here:
Contrary to what the editorial claims, a recession when fuel prices are low and headed lower is an excellent time to announce a schedule of higher taxes on fuel volumes levied on consumers.
Posted by: GNP at December 27, 2008 09:55 AM
In 2003, the fed govt did try a block grant for providing temporary fiscal relief to states. GAO did an assessment here: http://gao.gov/products/GAO-04-736R. A not-insignificant number of senators dislike the lack of accountability; as GAO noted, "uses of such funds are difficult or impossible to track." That's why Washington folks are focused on Medicaid FMAP and other forms of spending to provide fiscal relief, i.e. by easing budget holes in a targeted manner.
By the way, those of you following the economic stimulus package may want to read this article, as it outlines Obama's principles for a package: http://www.politico.com/blogs/thecrypt/1208/Reid_preps_850_billion_stimulus.html
Posted by: DCK at January 1, 2009 12:27 PM