StanCollender'sCapitalGainsandGames Washington, Wall Street and Everything in Between

Why the Economy Needs Spending, Not Tax Cuts

24 Oct 2009
Posted by Bruce Bartlett

Yesterday, Mort Zuckerman, owner of the New York Daily News, exercised his prerogative by publishing an essay in that publication complaining that "Obama's spending and borrowing leaves U.S. gasping for air."

This is common criticism among Republicans, who have a vested interest in blaming everything bad that happens on the Democrats. The implication is that if voters weren't so stupid and had instead elected John McCain to be president then the budget would be balanced, the debt would have disappeared, and the economy would be booming.

Mr. Zuckerman, however, is generally thought to be a liberal Democrat. And as a newspaper owner he likes to pretend that he is a journalist. But he or whoever ghosted this op-ed for him neglected to check the facts.

According to the Congressional Budget Office's January 2009 estimate for fiscal year 2009, outlays were projected to be $3,543 billion and revenues were projected to be $2,357 billion, leaving a deficit of $1,186 billion. Keep in mind that these estimates were made before Obama took office, based on existing law and policy, and did not take into account any actions that Obama might implement.

Therefore, unless one thinks that McCain would have somehow or other raised taxes and cut spending (with a Democratic Congress), rather than enacting a stimulus of his own, then a deficit of $1.2 trillion was baked in the cake the day Obama took office. Any suggestion that McCain would have brought in a lower deficit is simply fanciful.

Now let's fast forward to the end of fiscal year 2009, which ended on September 30. According to CBO, it ended with spending at $3,515 billion and revenues of $2,106 billion for a deficit of $1,409 billion.

To recap, the deficit came in $223 billion higher than projected, but spending was $28 billion and revenues were $251 billion less than expected. Thus we can conclude that more than 100 percent of the increase in the deficit since January is accounted for by lower revenues. Not one penny is due to higher spending.

It should be further noted that revenues are lower to a large extent because of tax cuts included in the February stimulus. According to the Joint Committee on Taxation, these tax cuts reduced revenues in FY2009 by $98 billion over what would otherwise have been the case. This is important because the Republican position has consistently been that tax cuts and only tax cuts are an appropriate response to the economic crisis.

According to the Council of Economic Advisers, as of August the actual budgetary effect of the February stimulus was to reduce revenues by $62.6 billion and raise spending by $88.8 billion. Of the spending, the vast bulk went to transfers such as extended unemployment benefits and aid to state and local governments, which may have prevented cuts in spending that would otherwise have occurred but probably didn't do anything to increase spending. Only $16.5 billion in stimulus funds went to investment outlays for things such as public works. This is a trivial amount of money in a $14 trillion economy.

As if we needed further evidence that transfers have virtually no stimulative effect, the Bureau of Labor Statistics just issued a report on the 2008 tax rebate showing that only 30 percent of the money was spent; the rest was saved, thus providing no stimulus to short-run growth. (See also this CBO report and this new working paper from the National Bureau of Economic Research confirming this analysis.) On January 24, 2008, George W. Bush assured the country that a tax rebate was just the right medicine to prevent an economic downturn.

It continues to amaze me that no one on the left or right seems to have noticed that the essential factor causing the economic downturn is a decline in velocity: the number of times that money turns over in the economy, which is measured as the ratio of the money supply to GDP. In 2006 and 2007 this ratio was 1.9. I take that as normal. In 2008, velocity fell to 1.76 and currently is 1.69. (I divided end of year M2 into 4th quarter GDP; the latest figure is 2nd quarter GDP divided by end of June money supply.)

If velocity were 1.9 instead of 1.69, 2nd quarter GDP would have been $1.6 trillion higher. Therefore, no recession. The output gap would have simply disappeared. From this I conclude that a lack of spending in the economy is the central problem and the only policies that will help are those that increase spending - consumer spending, investment spending, net exports or government spending. How tax cuts would have helped - or at least the type of tax cuts advocated by Republicans - is a mystery to me.

I continue to believe that the Republican position is nonsensical. Final proof is that the previously cited CBO report shows total federal revenues coming in at 14.9 percent of the gross domestic product in FY2009. According to the Office of Management and Budget, one has to go back to 1950 to find a year when federal revenues were lower as a share of GDP. For reference, revenues averaged 18 percent of GDP during the Reagan administration and were never lower than 17.3 percent - 2.4 percent of GDP above where they are now.

I think there are grounds on which to criticize the Obama administration's anti-recession actions. But spending too much is not one of them. Indeed, based on this analysis, it is pretty obvious that spending - real spending on things like public works - has been grossly inadequate. The idea that Reagan-style tax cuts would have done anything is just nuts.

Bruce, You are so correct. No


You are so correct.

No one talks about the tax cut stimulus program of 2008.

What also worries me is that some of the tax cuts are also baked into the system as permanent tax cuts. And, the worst are tax earmarks--tax cuts for just one firm or a few firms.

Doing some publicity about tax earmarks would be a public good and would draw attention to counterpart of regular earmarks.

Keep it up. Hope we have more moderate Republicans like you again.

Equally NUTS are those who

Equally NUTS are those who continue to believe that the "Keynesian multiplier" exists. The key to getting well is the consumer, who largely pays no taxes, and receives little to no benefit from government "pump priming". That leaves jobs, jobs, jobs!

From Where From Whom?

Where are those jobs going to come from?

Republican policies of the last 30 years have led to the systematic destruction of the median wage. This includes refusal to countenance health care reform, which has meant that most people don't see any gain from the increased employment costs borne by employers.

This has led to the worst of both worlds. Higher employment costs, stagnant median wage.

Since consumers don't have money, and credit isn't sustainable, who's going to spend money to stimulate the production of jobs?


The path forward is clear

The path forward is clear:
tax the rich,
cut taxes for the middle class,
balanced trade (lower US$),
massive infrastructure spending.
We know what's required, but, for reasons I don't understand, the political will is lacking.

The "increased savings" is really debt-reduction by the Middle-class. The Middle-class overextended the last two decades, and must now reduce their debt.

Barring inflation, Middle-class families need to reduce their debt, so the demand reduction must be replaced by investment spending. Business won't invest as long as capacity utilization remain at the current low level (70%).

The federal government must pick up the slack with massive infrastructure investments like, smart grids, energy efficiency, renewable energy, communications infrastructure, as well as traditional roads and bridges.

Spending on infrastructure is an investment that can be payed back over time. Infrastructure spending results in higher growth, thus higher revenues. The higher growth will make today's deficits look puny compared to tomorrows much higher GDP.

In addition, with the ascendancy of the developing world, and the increased global population, we need to improve our energy efficiency and come up with new products that use less materials as well as less energy. If we don't, our standard of living will be reduced.

We also need to invest heavily into education to enhance labor mobility into new technologies and techniques. Education is also an important component of Research & Development for developing new products.

Supply-Side economics are about increasing productivity, Keynesian (or Demand-Side) is about creating demand for that increased productivity.

We have greatly increased productivity during the last decades, but the gains have mostly accumulated at the top layer of society. Since the rich already consume as much as they want (more or less), there is no corresponding increase in demand for that increased productive capacity. Since we produce more with less people, there is less demand for workers. Thus higher unemployment; thus more competition for jobs; thus lower wages; thus even more wealth transferred to the rich; thus less demand; thus more layoffs; thus ...

Bruce is correct, in the late 70s, the Demand-Side had run amok. Today, the Supply-Side has run amok.

Starting with Reagan, most productivity gains has been captured by the rich. The middle class has tried to keep up by reducing savings and going into debt. But you can only borrow so much before the inevitable day of reckoning arrives. It took 25 years for it to show up, bit it's here, and we have to deal with it.

It's real simple, double the productivity, allow the top 1% to horde all the gains, then because only half the workers are needed, there is massive unemployment. Why is this so difficult to understand?

Devastating to the phony deficit hawks

I am fascinated by your analysis and your ability to explain this in simple language.

Wow, when you burn bridges, you sure don't f&^% around!

Yeah, seriously. I do wonder

Yeah, seriously. I do wonder why he didn't go ahead and bomb that bridge when W was still head idiot, but better late than never.

"It continues to amaze me

"It continues to amaze me that no one on the left or right seems to have noticed that the essential factor causing the economic downturn is a decline in velocity"

Let's be fair: Krugman and DeLong (at the very least) have been explaining the downturn and justifying fiscal stimulus with public spending in exactly this way since December 2008 if not earlier - and they have been doing this partly because of the Chicago School opposition and Republican efforts to make the stimulus bill less effective.

Their blogs and news articles have specifically cited the decline in velocity and the propensity of people to save in current conditions as a reason why transfers are less useful in getting people working than spending programs; and DeLong has gone into depth regarding the connection between the fall in velocity with zero-interest-rate policies and the need for fiscal policy.

Production Efeciency or productivity gains help???WHO???

Years ago before most of you reading this were born I was employed as an Industrial Engr.
Labor efficiency was our mandate and we did perform production miracles by standards of the '50's and '60's.

Then most manufacturing labor was unionized and productivity gains were partially passed on to labor.

That has vastly changed today. with so many management techniques for manipulation of records. Smart management can deny or obfiscate and threaten to sell out or transfer production to other manufacturing outside the state or country as a threat against collective barganing gains by labor and labor has little leverage with small employeers who move , open or close a small manufacturing plants often with federal money guarantees.

We let our vast network of ratepayer-owned utilities of public transportation water, sewer, electricity etc. gradually become regulated? Utilities owned by wealthy stockholders and institutions. Some of the working people may have beeen able to take advantage of a tax deduction for an IRA or company 401K or interest rate deduction but mostly the people who benefited were those who made more than enough to live on and didn't have to scrimp and near starve to make ends meet.

So all benefits tax deduction and tax favored and tax sheltered investments went to the better paid, better protected, less likely to be drafted into service. So look at President Bush's war record. He cost our government quite a load to train him as a fighter pilot so he could work getting a repubilican elected in Alabama and stay awol for a year till his repubiclan Congressman father could get his record squared away with his buddies in the Texas Nat. Guard.

How often we read about some firm negotiating with various states to get up-front labor law and tax advantages before commiting to start-up a manufacturing or even a retail business. We need laws that stop any business from relocating for tax or law advantages that is why labor unions have worked so hard to force federal law to supercede State law.

All business that can be considered to be "interstate commerce" should have to follow one set of Fed regulations in dealings with labor of all categories And we need to find a way to keep big monied organizations from manipulation of collective bargaining laws "The nat. assoc. of Manfactures, Chamber of commerce etc are constantly spending tons of money at state and federal level to keep workers begging and hungry.

There was a short period of time when everyday working people like me made real gains in the share of the benefits of productivity , set up by the legislation and philosophy of the "NEW DEAL" which of course was socialism in democracy.
It led to vast expansion of the middle class gave me a free education via the GI BILL. America prospered. So did the whole world until Nixon then Reagan & the Bushes destroyed it to favor one percent of this great country's population! How did they get so many of you to vote for their BS??? Most of you sold your economic rights for abortion limitation, gun control fear, and all manner of absurd population control rhetoric to keep you from fighting for your financial legal rights.

Virtually every segment of mass media, News papers Television radio are all bought and owned by labor-adverse managment. Because of the capitalist system shared interest creates sympathetic responses for business management.Then of course they have all the money!!! And in our modern society it's money that buys headlines and television stories that are spun to favor wealthy interests and votes in State and federal Gov..
Why would we be so stupid as to let all those with gold-plated health plans tell us we can't afford to have health care for everyone! when every study ever done by any creditable research agency has proven that covering everyone with single payer like I have as a Vet or senior citizen costs us much less than the absurd non-system we are using, thanks to privatizing something that never should have been capitalistically organized.
None of you can remember, but when I was young most insurance was mutually owned by groups of citizens. Ever notice how many Insurance companies have that term "Mutual" in their name? Thats because they wern't stockholder owened companies when they started out.
Bright minds with dreams of $$$'s not protection for the people took those "mutuals" Public as stock companies.The mutual protection societies became Public Insurance Co's of all types to make money and they told everyone that they could do it cheaper by using the profit motive to garner vast management improvements and thereby give better overall protection to people ,their homes businesses health life etc. Why is it that when the shit hits the fan we go back to socialism to solve the problems??? It wasen't stockholder monies that saved our proud bonus paying "worlds biggest" insurance company!!!AIG. I've just read all about how Wall Streets brightest and best saved the world's financial system! By Wall Streets best salesman David Wessel.
I will bet when all the fallout stops falling we will find that Wall Streets around the world innovating CDO's CDS's and numerous other sophisticated structured idiocy instruments of mass deception. Which no sane person would ever let fail, caused the failure because greed did to greedy as greed does to everything.
When this freefall of finance started I said to my wife, This is the best thing that could posible happen nothing else could make our world Leaders stop their mad lust for growth and look for alternatives to suppling the basic needs of our world's peoples without destroying the world's life saving biosphere. OUR OCEANS have problems. Desertification is destroying millions of acres a year of food producing cropland. When I was a kid the largest underground aquafer in the US was full. when I got back from Korea in feb'53, my friend Charly Marten then 50yrs old told me he had just had tp deepen his well to 250 ft.His first drilling was 50 ft. 20 yrs before. The Ogalalla aquafer is dry in several areas. When I was a kid there were salmon in every river on the west and east coasts that had them in 1900! Now go find even one that has a decent run!!!
All this progress and development didn't buy us one mouthful of salmon and all the homes we sprawled over vast areas of crop land could have been put on land less usable for food I remember when "OLD EUROPE" was ridiculed for quaint cities and seemingly cramped living quarters, struggling to save their forests we seemingly had them in abundance. We could waste timber on 5000 sq.ft. houses for a retired couple??? or second home??? I seem to remember that our recent presidential hopeful said he had 8 or ? He wasn't sure. He was sure that he was a grad of Anapolis Naval college so like me he got his education at government "the peoples expense" Isn't it odd that republicans can't find a war they don't like? Of course most democrats in Congress have Defense dept moneys in their districts so they love war too... War Pays Big! So does "Clean Coal" Mountaintop removal "doesen't hurt streams or rivers" "Sludge impoundments are safe" Every coal fired power plant has one and "everyone is safe" Until they aren't (Google buffalo creek!)
We worked very hard , making calls etc. for Mr Obama' election campaign and mow we wonder why? We bought the "change we can believe in"Story? Transparency in all government activity ( sunshine is the best medicine for fraud avoidance) not directly associated with national security, We'll Run the Lobbyists out of the legislative process so legislators can debate and plan what would be better for the American People not what makes money for insurance co's, or Defense Contractors, or coal producers, or any special interest benefitting from the people's business. So why aren't abuses of power being investigated by competent legal staff??? Why does the ACLU and a dozen other public service groups have to fight to get publc documents that represent the day to day operation of the people's business. Documents that are a public record of government business? Mr. Obama promised to open up government to the people, I think? Well!!!Then there were the Tax cuts for the wealthy that had to be repealed!!!I think my anger is as deep as my age and I want to get back to an America that cares for its people more that for AIG or CITYGROUP or ABC.or Goldman or Morgan.
Monte McKenzie

Monte McKenzie's Complaint

Like you, I am a World War II combat veteran, educated via the GI Bill. Like you, I was an enthusiastic supporter of Obama. And from your writing, I would guess that you are disgusted as I am with our new President who promised a lot, gives eloquent speeches, hasn't the guts to fight for anything and has been captured by the same moneyed interests (Summers, Geithner, etc.)as our Congress long ago was. You are right, with a population so intelligent that they buy two wars, all the side issues of abortion (anti's are all men!), guns, terrorists, immigrants and whatever, is your question Who? without answer very surprising?


It's true that Krugman and DeLong have mentioned the decline in velocity, but neither emphasize it or make it central to their analysis of the crisis. To me it is the linkage between the monetarist view and the Keynesian view of our current economic problems. Once one accepts that a fall in velocity has the same economic effects as a decline in the money supply it becomes very easy to reconcile the Keynesian and monetarist perspectives.

Well that spending so far has

Well that spending so far has worked so well hasnt it Bruce????

As for the 2008 and 2009 tax cuts. of course those didnt work. They werent rate reductions and thus didnt impact incentives.

""Keep it up. Hope we have more moderate Republicans like you again.""

Of course you want more moderate Republicans like Bruce Bartlett, THEY LOSE.......

""The path forward is clear:
tax the rich,
cut taxes for the middle class,
balanced trade (lower US$),
massive infrastructure spending.
We know what's required, but, for reasons I don't understand, the political will is lacking.""

Boy, this is a recipe for economic disaster. A weaker dollar and high marginal tax rates will make america stronger and more competitive??? HARDLY. What it will do is lower the US standard of living, result in weaker not stronger manufacturing(counter but true), higher commodity prices and faster inflation. In essence you want 1978 again.

""The federal government must pick up the slack with massive infrastructure investments like, smart grids, energy efficiency, renewable energy, communications infrastructure, as well as traditional roads and bridges.""

This is indeed what Obama is doing and it is failing miserably. Every dollar sucked out of the private sector to the public sector is a dollar that wont go to create the next new innovation. Innovations are created and brought to market by the private sector, not the public sector.

""Republican policies of the last 30 years have led to the systematic destruction of the median wage.""

Who knew that the signer of NAFTA, Bill Clinton was a Republican???

If you dare.


Innovations like oh... say... The Internet? were created by the private sector? Same goes for thousands of high-tech startups based on work originally funded with government grants. Go into any university lab, and see where their money comes from. What those people end up doing with their work is starting private sector businesses - of which the government has no stake. They might get additional capital from private sources to help make their business operate, but the initial seed is often planted by the government. It's a pretty dang good deal.

This idea that government spending somehow "sucks money out of the private sector" is absurd. What do you think government spending is? It's money paid for goods and services TO the private sector. Sheesh.

where does one start?

I found this to be particularly hilarious: "As if we needed further evidence that transfers have virtually no stimulative effect, the Bureau of Labor Statistics just issued a report on the 2008 tax rebate showing that only 30 percent of the money was spent; the rest was saved, thus providing no stimulus to short-run growth"...

Whoa! Saved money?!?! What? Saved in shoe boxes or in the mattress?

Could it be that 'saved money is actually working in savings accounts at banks, credit unions, or various retirement plans?

The fact of the matter is entitlements that are killing the economy...

So why NOT tax cuts being matched by cuts in socialist, nanny state entitlement programs?

Circulating Money

The money saved is not circulating through banks the way it normally should. Look at the Fed data; excess reserves are massive. That's money banks could lend in a second if they wanted to, but they don't.

"excess reserves the banks could lend if they wanted"

The reason they aren't being lent is that the Fed is paying interest on them, to prevent the banks from lending them.

This is intentional Fed policy. Bernanke himself has described it as "contractionary", as in virtuous, in that it's allowed the Fed to prop up liquidity at the banks as institutions without inflationary effects on the general economy.

Jim Hamilton, Scott Sumner and a few others noted this when it happened and were startled -- why take a "contractionary" policy in a recession? -- but most observers have just looked at the huge number for excess reserves and totally missed the major import of the Fed paying interest on them, which changes the game from normal times entirely.

The Culture of Dreams and Denial

We have lost control of the monster and it is but a matter of time before it comes back to eat us alive. I will give a tip of the cap to Bruce for pointing out (in past columns) the lack of political will from the politicians to reign in spending lest they lose their cushy jobs. On the other hand, who elects these people? Why "we" do of course. Some segments of "we" want our SS and Medicare ponzi scam to continue, some aspects of "we" want our big defense budget and other elements of "we" want to keep growing the government to take care of everyone with no willingness to address how it gets paid for.

It's easy to blame Bush for the results of stuff that Clinton did just like it's easy to yell at Obama for the results of what policies came before he got into office. Of course he just wants to accelerate the pace on the road to ruin but "HopenChange" Kool-Aid precludes people from addressing reality.

Change expectations to fix velocity


The quick fix to the velocity problem is for the Fed to set an explicit inflation target or nominal income target. This would improve expectations of future economic activity and lead to increased spending today. As Scott Sumner has argued, a collapse in inflationary expectations late last year caused the rapid decline in velocity and turned the recession into something ugly. See here for more.

FY 2009 deficit inflated by temporary & nonstimulative spending

The FY 2009 deficit was inflated by a great deal of temporary "spending," authorized by the preceding Republican president, that did essentially nothing to raise aggregate demand. $154 billion was spent on TARP and $91 billion was given to GSEs for a total of $245 billion. This easily exceeded the approximately $190 billion in ARRA direct spending and tax expenditures for the just completed fiscal year. The money transfered via TARP and to the GSEs may have been necessary but it certainly didn't provide the same fiscal stimulus that the direct spending provisions of ARRA did.

P.S. ARRA was diluted by Senate "centrists" who were hellbent to limit its size, and insert a costly, ineffective and untimely AMT patch at the expense of more state transfers and infrastructure spending. That act of utter stupidity may have been bipartisan in terms of the party labels but it was clearly Republican in spirit.


Lack of spending and the low velocity of money are the problem? Wow, you really don't get it. The problem is we are in debt to our eyeballs. Average Joe is broke and has not saved a cent since the 90's. Consumer debt to income ratio topped at 133% at the start of 2008. That is absolutely outrageous and a historical high. All of our governments are broke as well. The answer so far has been to print money. That bought us some time, but sooner or later the dollar will crash. With gold now consistently over 1000 and our currency beginning to drop against the rest of the world, the crash is coming. We cannot stand the strain of continued unemployment and do not have the savings to support a spending stimulus. Spend more, add more debt? You should find another job...

If it were that easy...

You do realize that a "weak" dollar is stimulative, right? We want American goods to be purchased by other countries. This stimulates exports and puts Americans to work.

"I continue to believe that

"I continue to believe that the Republican position is nonsensical. "

That verges on tautology.

You don't cut spending in a recession/depression

This is something that even an intelligent child knows, which is why the rightwing whackjobs on here simply never grasp it. Every time spending has been cut in a recession/depression, it has prolonged it. That's simply a matter of empirical record. If you tighten spending now, you'll lose more jobs, damage the economy further, the deficit will worsen, because the economy is contracting, and whatever savings you make will simply be absorbed by the loss of tax revenues. Haven't you people ever heard of false economy?


It's true that the Fed is paying interest on reserves, but it is quite minuscule--.025%. Nevertheless, it does reduce the opportunity cost of not lending. I think the idea of a negative rate should have been explored.

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