Why Spending Stimulus Plans Fail

Brian Riedl of the Heritage Foundation has an excellent op-ed in today’s Wall Street Journal.

It begins:

Congressional Democrats are now demanding another economic stimulus package to “inject” as much as $300 billion into the economy. The package will fail — just like last year’s $333 billion in emergency spending and $150 billion in tax rebates failed. There’s a simple reason why.

Government stimulus bills are based on the idea that feeding new money into the economy will increase demand, and thus production. But where does government get this money? Congress doesn’t have its own stash. Every dollar it injects into the economy must first be taxed or borrowed out of the economy. No new spending power is created. It’s merely redistributed from one group of people to another.

Of course, advocates of stimulus respond that redistributing money from “savers” to “spenders” will lead to additional spending. That assumes that savers store spare cash in their mattresses, thereby removing it from the economy. In reality, nearly all Americans either invest their savings (where it finances business investment) or deposit it in banks (which quickly lend it to others to spend). The money gets spent whether it is initially consumed or saved.

Governments don’t create new purchasing power out of thin air. If Congress funds new spending with taxes, it is redistributing existing income. If the money is borrowed from American investors, those investors will have that much less to invest or to spend in the private economy. If the money is borrowed from foreigners, the balance of payments must still balance. That means reducing net exports through exchange-rate adjustments, thereby leaving net spending on the economy unchanged. […]

Lawmakers commit this fallacy repeatedly. They tout unemployment and food-stamp spending as stimulus without asking where the programs’ funding comes from. They hype a federal bailout of the states as stimulus, as if having Congress do the taxing and borrowing instead of state governments makes it a free lunch.

And, especially in this era, when “our crumbling infrastructure” seems to have become the new mantra, legislators and lobbyists tout a 2002 Department of Transportation (DOT) study that they believe proves that every $1 billion spent on highways adds 47,576 new jobs to the economy.

The problem is that the study doesn’t actually make that claim. It stated that spending $1 billion on highways would require 47,576 workers (or more precisely, would require 26,524 workers, who then spend their income elsewhere, supporting an additional 21,052 workers). But before the government can spend $1 billion hiring road builders and purchasing asphalt, it must first tax or borrow $1 billion from other sectors of the economy, which then lose a similar number of jobs.

In other words, highway spending merely transfers jobs and income from one part of the economy to another. As economist Ronald Utt has explained, “The only way that $1 billion of new highway spending can create 47,576 new jobs is if the $1 billion appears out of nowhere as if it were manna from heaven.” […]

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