As Fiscal Engine Stalls, the Mechanics Line Up
By LOUIS UCHITELLE
November 24, 2001
s Congress struggles to pass a stimulus package, a debate is breaking out among economists over whether the $75 billion to $100 billion that the House and Senate seem willing to spend will be enough to pull the economy out of its downturn.
With a declaration expected as early as Monday that the economy is officially in recession, some experts talk about needing a fiscal stimulus package that starts at $100 billion and ranges up to $400 billion. Such thinking stands in contrast to the more common view that the current downturn will be relatively mild, requiring no more help than Congress is currently considering.
Those pushing for greater stimulus argue that consumers and business are pulling back on too many fronts and worry that the Federal Reserve's interest rate cuts will fail to reverse the decline. The government, they argue, must move quickly to make up the shortfall through a combination of public spending, subsidies and tax cuts.
"Whatever is done has to be done fast," said Peter L. Bernstein, an economist and author, most recently, of "The Power of Gold" (John Wiley, 2000), who argues that Washington should inject at least $150 billion in fiscal stimulus into the economy, most of it through public spending.
Not since the early 1970's, when President Richard M. Nixon famously declared that everyone had become a believer in Keynesian pump-priming, has there been so much support for fiscal stimulus.
But how much? Those who say that less than $100 billion should be plenty to do the job argue that the current downturn will be mild and will almost certainly be over by early summer. Too big an infusion, they argue, would not only be unnecessary but potentially inflationary.
That is the view of President Bush's economic advisers, along with many other economists, mainly on Wall Street, who share the consensus forecast of a mild recession.
"So far, we do not see the need for much public spending at all," said R. Glenn Hubbard, chairman of President Bush's Council of Economic Advisers. "We do not think that this is a deep downturn."
The Republican-controlled House recently approved a stimulus bill that relies mainly on tax breaks to encourage private-sector spending and investment, an approach that Mr. Bush also favors, although his cost ceiling would be closer to $75 billion, not the House's $100 billion. The Democratic-controlled Senate, on the other hand, is considering legislation that relies much more on federal spending and subsidies than on tax benefits.
The pessimism that laces the thinking of many economists outside the consensus holds that the recessionary forces in the economy are much greater than the administration and most Wall Street forecasters realize.
"The kind of numbers we should be thinking about are certainly more than $100 billion and probably more than $150 billion," said Joseph E. Stiglitz, a Nobel Prize-winning economist at Columbia University who served as an economic adviser to President Bill Clinton.
"You have to think big numbers," Mr. Stiglitz said, "unless you believe that the economy will recover quickly or you think the Fed's monetary policy will be more effective than it has been."
Consumers and business, they argue, had made the boom years possible through an unsustainable process: record borrowing and robust spending while the federal government pulled back, eventually running up large surpluses.
Making matters worse, state and municipal governments are beginning to shrink spending as tax revenues fall sharply in a weak economy. Every state but Vermont is required by law to balance its budget.
"State tax revenues fell by 3.5 percent — $5 billion — in the third quarter, the first time these revenues have fallen rather than risen in the 10 years that we have collected data," said Donald Boyd, deputy director of the Center for the Study of the States in Albany.
"If this keeps up, the federal government will have to pump an additional $20 billion a year into the states just to keep spending even," Mr. Boyd added. "Many states have already ordered hiring freezes, and construction projects are being postponed all over the place."
Given such problems, the only solution, according to those challenging the conventional wisdom, is for the federal government to pick up the slack, by swinging rapidly from budget surpluses to budget deficits. Support for this approach is beginning to broaden beyond its usual liberal base.
Advocates say the most important thing is to direct money to those who will spend it, mainly through richer unemployment benefits, stepped up grants to the states, increases in military spending and bigger outlays for public works projects that can be undertaken quickly. School repair and highway maintenance fall into this category.
"My view is that the federal government should spend a lot of money, and it will," said Paul A. Volcker, a former chairman of the Federal Reserve, declining to say how much might be necessary to lift the economy. "Tax cuts," he added, "do not make a lot of sense, either as tax policy or as short-run stimulus. They are doubly damned."
Like many economists, Mr. Volcker argues that tax cuts are too uncertain a spur. A tax break may not persuade a family to increase its spending if it is already deeply in debt, or persuade a hotel owner to hire more housekeepers if the hotel is half-empty.
Among economists sharing this view, James K. Galbraith of the University of Texas favors the greatest amount of spending.
"Normally in wartime, large-scale support to the domestic economy is not needed," Mr. Galbraith said. "But neither the $20 billion already appropriated for the military, nor the $20 billion allocated for relief and reconstruction in New York City nor the $15 billion passed out to the airlines is nearly enough to deal with the nation's economic problems."
He called for an increase in federal budget deficits from roughly zero today to the "breathtaking sum" of $400 billion to $600 billion a year, or 4 to 6 percent of gross domestic product. "Public spending — let me disdain the public relations term `investment' — has a great macroeconomic advantage over tax cuts," he said recently.
Those who favor tax cuts, however, argue that permanent, across- the-board reductions in corporate and individual income taxes are a powerful incentive to spend and invest. According to this view, when entrepreneurs are allowed to keep more of what they earn, they are quicker to invest in new equipment, even when the economy is weak. The investment generates jobs, income and a willingness to spend, especially when tax cuts allow a family to keep more of its wages.
"People can look ahead and plan," said John Makin, an economist at the conservative American Enterprise Institute, "and if you are convinced that less tax burden is an incentive, then the economy, when it begins to recover, will have more legs."
By contrast, there is broad agreement among the advocates of spending that whatever the fiscal stimulus, it should be temporary, fading out as the economy revives. The advocates would include carefully aimed tax cuts in their plans; for example, a tax benefit for companies that step up investment, but only if they do so quickly.
"You want something that has a substantial kick in the next 6 months and is nearly entirely gone in 12 months," said Robert Greenstein, executive director of the Center on Budget and Policy Priorities. "You can always extend the stimulus if things go wrong."
At the top of most lists is the sweetening of unemployment benefits, which would add perhaps $30 billion or more to spending in a relatively short time. So would subsidizing health insurance premiums for unemployed workers who had lost company-paid benefits — another popular proposal among many mainstream economists and Senate Democrats.
Even conservatives like William A. Niskanen, chairman of the libertarian Cato Institute, who prefers across-the-board tax cuts as the best prescription for the economy, would vote for stepped-up unemployment benefits and subsidized health insurance premiums — if a financial package must be tried.
"If you are going to have a package," he said, "I would want across- the-board tax-rate reductions, and I would also be more than happy to increase unemployment insurance payments and pick up part of the payment for health insurance for people who are laid off and lose their coverage. That is not stimulus; that is helping people hurt by the weak economy."
Mr. Niskanen holds that consumer demand and a willingness to spend are latent in the economy and that people will respond as long as they are not so fearful that they simply shut down.
Mr. Galbraith disagrees. Household indebtedness has not yet reached the danger point, he says, but a crisis is approaching, one in which Americans will put more emphasis on saving than on spending. If that happens, government spending must rise simply to stabilize the economy.
"It becomes a question," he said, "of who does the borrowing and spending that will be necessary."
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