04 February 2009

Bailout #2: The Stimulus Package and Incentives

The Objectivist
Stimulus Package: Adding Fuel to the Irresponsibility-Fire
Dunkirk-Fredonia Observer
February 2, 2009

There is no evidence that the House stimulus bill will work. Even if it did work in the short term, it will have horrendous long-term effects because it transfers assets from the private to the public sector and because it ratchets up the national debt. However, I’d like to focus on another problem. The bill promotes the worst habits of state and local government.

The House passed a bill providing for $819 billion to stimulate the economy. This actually amounts to $1.17 trillion once the $347 billion in interest costs are taken into consideration. The arrogant Senate is currently considering an even more generous bill worth $888 billion, not counting interest. This is in addition to the $700 billion that has already been authorized to bail out the banks. A billion here and a billion there and soon we are talking real money.

My favorite bartender, quoting comedian John Stewart, pointed out that when one adds the Senate’s stimulus bill to the bank-bailout bill, the total is $1.59 trillion. If we divide this amount by the number of adults (230 million), the government could have given each individual $6,900 per adult ($13,800 per couple). In the short term, this is as likely as the stimulus plan to bring the foreclosure crisis to a screeching halt and eliminate the troubled asset problem that endangers many banks. Ask yourself whether you would prefer to receive a check for $13,800 or have Senators Schumer, Kennedy, and Dodd shovel out the money to their campaign donors and other favored groups.

The stimulus package contains $200 billion for the states. One of the main problems with it is the perverse incentives this will provide. As the Wall Street Journal pointed out, state spending has exploded in the last five years. State spending has increased roughly 7% per year from 2003-2007. That is, it increased at 34% compared to 19% inflation during that period. The states also went heavily into debt. Their debt load doubled to $2.23 trillion in 2008 from $1.14 trillion a decade earlier. The $2.23 trillion does not even include the nearly $1.5 trillion in unfunded health and pension liabilities they’ve allowed to pile up. The last thing such profligate spenders need is to have their drunken spending sprees covered by taxpayers from responsible states. Yet this is precisely what the bill does.

As usual, New York is especially worthy of contempt. It faces an estimated $12 billion deficit. But, as the Wall Street Journal points out, New York's government spent more than $1,000 a year more per family than in the average state. New York would have a $5 billion surplus if it had limited its spending to the average for the 50 states. New York has the second highest taxes in the country, having only recently, and probably temporarily, been passed by New Jersey. The legislature still hasn’t passed the budget for this year and its process by which it does so is largely closed to public scrutiny.

As if the effects on the states weren’t bad enough, the effects on education spending are just as bad. The bill contains $159 billion in additional education spending. The stimulus bill grants $39 billion for school districts and public colleges and another $25 billion for high-priority state needs, which may include education. Outside of New York City, New York education costs constitute 62% of the property taxes. When you control for home value, New York has 9 of the 10 highest taxed counties in the country. The driving force is spending. In 2008-2009, New York spent $18,768 per pupil. This is more than any other state and involves a 7.9% annual rate of increase from 2000 to 2006. Why would anyone think it is wise to subsidize school boards that spent their way into oblivion? Worse, why should a country already up to its neck in debt further mortgage its future to bail out these big spenders?

The same concern applies to higher education spending. From 1982 to 2007, college tuition and fees rose 439%. Compare this to medical-care costs which rose 251% over that period and inflation (consumer price index) which rose 106%. Colleges and universities have devolved away from a focus on education and now contain politically correct multicultural affairs, affirmative action, and equal opportunity offices as well as a host of bureaucracies only distantly related to education. These include counseling centers, overstaffed police forces, sports teams, and armies of staff and administrators. So what does the stimulus bill do in response to this out-of-control spending? It pours gasoline onto the fire by providing tens of billions of dollars for more spending. This includes $10.3 billion more to provide a $2,500 tax credit for college and money for more grants, loans, etc. Apparently, Congress wants to keep on ratcheting up the subsidies for higher education and will later feign surprise when the exploding costs that the subsidies make possible end up making college increasingly unaffordable for anyone not rich or bathed in financial aid.

Incentives also apply when we increase welfare and exempt some people from paying their fair share. Already roughly 33% of taxpayers pay no income taxes. By expanding the earned-income tax credit (a credit that gives poor and working class people back the money they paid in via payroll taxes), the stimulus package furthers the notion that some people don’t have to pay for the government. The House also included $72 billion to extend jobless benefits and increase aid to the poor, including food stamps. There is an old slogan that if you tax something you’ll get less of it and if you subsidize it, you’ll get more of it. We are now increasing the subsidies for being poor and behaviors that cause it (for example, dropping out of school, not working, and having children out of wedlock). We can expect that these subsidies will get us more of these behaviors.

While Obama and his band of merry thieves spend the country into oblivion, Social Security and Medicare loom on the horizon. Social Security will start running in the red by 2017 and entitlement reform is still being ignored. The national debt keeps on climbing and the high tax rates make our country less competitive with each additional year. For example, estate and corporate taxes are very high by international standards.

Providing subsidies to states and school boards that have repeatedly shown themselves to be big spenders will only encourage more of the same. The stimulus bill’s effect on incentives will hurt us in the long run.


The Objectivist said...

The Practical Issue

In the previous section, Brian argued that we should distinguish the following issues.
1) Should there be bailouts?
2) How should the bailouts be spent?

This is a mistake. A bailout package is a particular bill. Whether we should support bailouts depends on the quality of the bills that are likely to be signed by Congress and Obama. If these all make the economy worse, then they should not be signed.

The Objectivist said...

The Theoretical Issue

Even the notion that the credit market has done better and therefore the bank bailouts were a success has several flaws.

First, the benefits are likely outweighed by the costs. Remember that a $700 bailout bill, probably $900B by the time interest is added in, is a huge drag on future income and will provide clear incentives for future government expansion that will also be a huge drag. To ignore this is not to engage in a cost-benefit analysis.

Also, the market would have eventually forced the banks to give up their huge reserves and lend out the money. Failure to do so causes lost profit-opportunities and it is hard to find a case where such behavior has been a long-term feature of the economy.

The Objectivist said...

Why would anyone think that the states spend too little or that we subsidize education with too few dollars?

In the absence of such an argument, it is hard to see why anyone would think this is a good way to jump start the economy.

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