Want to Stimulate an Economy? Cut Taxes.

Biden's Keynesian dreams are the stuff of which our nightmares are made.

There can be little argument that the Biden Administration is the largest Keynesian operation to come down the pike in decades. In one of his first acts, he tossed Milton Friedman out the door and started spending like crazy.

Now we find ourselves where John Maynard’s devotees always lead us, to the edge of a Keynesian cliff.

An overriding question and a constant source of conflict between conservatives and liberals is the role of government in the economy and whether or not government spending “stimulates” or can “kick start” an economy mired in stagnation. Conservatives tend to be free marketers who tend to hold economic positions in accordance with Adam Smith and the Austrian School – Hayek, Von Mises, Friedman, Sowell, etc., liberals are more prone to controlled/central planning/government intervention models that are Keynesian in nature.

So can a program of government spending generate economic results?

There are two answers to that question.

The first is that, yes, it can generate short run activity in the sense of the Keynesian definition, that definition being that activity can be generated by paying a guy to dig a hole and then paying another to fill it in. This definition can be validated from Chapter 10 of Keynes’ supposedly seminal work, The General Theory of Employment, Interest, and Money:

If the Treasury were to fill old bottles with banknotes, bury them at suitable depths in disused coalmines which are then filled up to the surface with town rubbish, and leave it to private enterprise on well-tried principles of laissez-faire to dig the notes up again (the right to do so being obtained, of course, by tendering for leases of the note-bearing territory), there need be no more unemployment and, with the help of the repercussions, the real income of the community, and its capital wealth also, would probably become a good deal greater than it actually is. It would, indeed, be more sensible to build houses and the like; but if there are political and practical difficulties in the way of this, the above would be better than nothing.

To me, a student trained in the Austrian School world of Uncle Miltie Friedman, creating an activity that yields no lasting value for the sake of simply creating an activity, as Keynes is clearly suggesting in this passage, sounds exactly like digging a hole and filling it in.

In that sense, when money is spent, it does “stimulate”…but there are several caveats that I can see that limit the benefits of that “stimulation”.

“Targeted” spending as a stimulus is not broad enough to generate system wide economic activity. Our government sees stimulus through the eyes of a “progressive” ideology. As such, it prefers to “target” stimulus funding to favored groups to avoid money going “the rich”. This is, of course, theoretical because governments tend to favor cronies (bank and union bailouts) and pet ideological initiatives (Biden’s green energy fantasies) and not a broad based infusion of economic relief.

Why? – Because progressives want it to fit their definition of “fairness”, thereby creating a social aspect to the “stimulus” and infusing non-economic decisions into an economic activity.

Running deficit and borrowing is inherently anti-stimulative. If a government has to borrow the money to create the activity (and running a deficit is the same as borrowing – it is creating a liability (debt) that has to be paid as some point in the future), then the economic activity must be enough to generate a net positive return or it is not stimulative, it is merely redistribution. In other words, if the expenditures do not return at least the same amount in tax revenues to the federal coffers as the principle and interest on the money borrowed, it is a net loss to the economy.

Velocity or the economic turnover rate matters. There can be no loss of velocity in the money that is injected into the economy, it all must be used for immediate and short term consumption and that consumption must be enough to deplete any existing inventories of goods and services to a point to incent the holders of those goods and services to create more. If one dollar is sidetracked into savings, to reduce existing debt or does not lower inventories low enough that they are replaced, there is no stimulative effect and the transactions become redistributive and not therefore stimulative. The old Obama “cash for clunkers” program or the WuFlu stimmy checks were a perfect example of this.

There has also been much made in the US of replacing ageing infrastructure as “stimulative” – there is also that same seductive song being sung in the UK even as we speak – but I would warn against sailing to those shores expecting anything different than greeted Odysseus as he sailed past on the Island of the Sirens.

Replacing existing capital assets is not inherently stimulative. If the money is spent to replace existing assets that do not currently inhibit commerce and there are rational alternatives, then the expenditures are not stimulative. One argument for replacement is that it provides construction jobs – and it does in the short term – but only for the life of the project.

Many years ago, we lived in Panama City Beach, Florida where the replacement of the Grand Lagoon Bridge on Thomas Drive was funded by Obamabucks stimulus money.

First, there was already a bridge there. Thomas Drive is an important access route to the hotels on the beach and there was always some congestion over the bridge during the high traffic periods of tourist season but due to the restrictions on Thomas Drive on the Beach side, the bridge was not always the source of the congestion, so building a bridge with a higher traffic capacity might be a nice idea but really won’t solve the problem. There are also rational alternatives to crossing the bridge, like Front Beach Road – if the bridge was out, there still is a way to access St. Andrews State Park and the hotels on the east end…takes more time but still accomplishes the task.

Did the bridge immediately spur a rash of other bridge building or an increase in retail business – even today, a decade later, I can’t see that it did.

It is the same in business, which is the reason that a capital asset like a new building will have a 25 year depreciation life – that spending by the business does not accrue an immediate benefit to the company. It is a long term investment that supports future revenue generation but does nothing to immediately boost revenue generating activity to equal the immediate cost.

There is a rational case for replacing infrastructure for safety reasons and even economic cases for replacing assets where there are no rational alternatives to them – but those are few and far between, for that reason most infrastructure replacement/improvements will not carry a true stimulative effect.

Infrastructure spending has a hidden cost. The US highway system is often listed as a success in federal spending but we cannot ignore that there was an economic cost that was paid. As an example here, we have to look no farther than what happened to the towns along the historical route to California, Route 66. After the construction of US interstate highway system, there are towns that ceased to exist due to traffic routed around and away from them. We did achieve a faster way to get to LA but we also killed many “mom and pop” hotels, restaurants and gas stations along the way. Hard to see how elimination of these businesses could be seen as stimulative to the towns that dried up and died.

In my initial premise I stated that government spending could be stimulative. In this assessment, I will use the definition of “spending” and “cost” most often used by our political class.

I have pointed out that:

1. Targeted government spending is not inherently stimulative if we must run deficits and borrow in excess of the return on that spending.

2. Velocity matters – any stimulative relief must generate broad economic activity or it is not sustainable.

3. Infrastructure spending is not inherently stimulative because replacing existing assets or those who have rational alternatives does not increase economic activity beyond the short-run creation of the asset.

4. Infrastructure spending has a hidden cost.

The most effective and immediate stimulative effect must address these four items for it to be “stimulative”.

So what could that “stimulative” effect be?

In the parlance of the federal government, any reduction in tax income is referred to as a “cost”. By extension of that logic, if something is defined as a “cost”, it must be preceded by spending. What fits that description? Tax cuts.

Tax cuts are commonly referred to by the “progressives” as a “costing” the government. “How can we pay for these cuts” is a common refrain to the desire to eliminate taxes but tax cuts do meet the criteria above:

• Tax cuts can be budgeted for to eliminate deficit spending – the approach of government baseline budgeting will never recognize this because the belief in Washington is that a reduction in increases of spending is termed as a “cut”.

• Eliminating a long term, ongoing tax burdens will encourage spending because citizens do not see it as a one-time event. Handing out targeted tax “rebates” that will be recovered in the next tax year does not encourage long term consumption and investment. “Progressives” do not support across the board tax rate cuts because their ideological filters do not allow them to qualify giving more money back to people who pay more in taxes as “fair”. When they contemplate tax relief, they want to implement regressive benefits by giving more back to people who pay less in taxes (and since 47% of filers have zero federal tax liabilities, it is easy to do). This is just another form of wealth redistribution.

• Infrastructure spending is something that sound good as a populist concept but is a ruse when it comes to actual stimulative effect. It may well be necessary for a number of valid reasons, but economic stimulus is not one of them.

Government can create economic stimulus – by cutting taxes.