Plummeting financial markets have increased the urgency of calls for a federal fiscal stimulus package to provide a temporary boost to consumer and business spending. This comes as the collapse of the housing market, weaker than expected holiday retail sales and declining employment have combined with turmoil in the financial markets to heighten the likelihood of a recession.
On the "monetary policy" side, the Federal Reserve has been taking unprecedented actions, notably dropping a key interest rate last week following stock market swoons around the world as fears spread regarding the global effects of a slowing U.S. economy. On January 24, the White House and the leadership of the House of Representatives said they had reached tentative agreement on "fiscal policy" action by the federal government, hoping to to jump-start the economy. It would feature a package of individual and business tax cuts costing $150 billion - an amount equal to roughly 1 percent of gross domestic product. Since the announcement, though, Bush-House proposal has come under criticism, and some senators have proposed various modifications that should come up for a vote within the next week. There will be intense pressure for the House and the Senate to then quickly reconcile their differences in order to speed passage of a plan in the hopes of moderating the sinking economy.
What's in the Bush-House stimulus package and how might it be modified in the Senate? Will it "work" in turning the economy around? How will it affect New York's economy?
The Bush-House Stimulus Plan
The plan announced on January 24 by House Speaker Nancy Pelosi and Treasury Secretary Henry Paulson would provide tax rebates to households and tax breaks to businesses. Bowing to widespread pressures, President George W. Bush backed away from his earlier plan to link any stimulus to extension of his signature tax cuts, now set to expire after 2010. Under the plan, married couples with incomes up to $150,000 would receive a rebate equal to 10 percent of taxable income up to $1,200; the rebates would then phase out so that very high-income households would not receive anything. For single people with incomes up to $75,000, the rebate would be a maximum of $600.
In a concession to House Democrats, the president agreed to include a rebate for low-income households who owed no federal income tax in 2007 but who had at least $3,000 in wage or self-employment earnings. For these wage-earning couples, the rebate would be a minimum of $600 ($300 for singles). In addition, any household with at least $1 of income tax rebate would receive $300 for each child.
The Treasury Department indicates that rebate checks would not be sent out until late spring at the earliest.
The Bush-House plan to stimulate business investment includes "bonus" depreciation and a doubling of the amount that small businesses can claim as an "expense" and so deduct from annual income. Both measures would lower business' 2008 tax payments by a total of $43 billion. The Congressional Budget Office concluded that such business investment incentives have modest effects at best. The Center on Budget and Policy Priorities has noted that 35 states, including New York, would likely lose revenue from state corporate income taxes if these business investment incentives were enacted since these states base their taxes on the federal definition of income.
What the Critics Say
While there is broad support for quick action to stimulate the economy, many economists and fiscal analysts have criticized the Bush-House plan on the grounds that it is poorly targeted and will not provide the maximum economic boost given its cost to the federal treasury. Senators are being lobbied furiously to make improvements. New York Times columnist Paul Krugman notes that the Bush-House plan would send "the bulk of the money to those who are doing OK financially." Indeed, the Tax Policy Center estimates that 58 percent of the individual rebates would go to the upper and upper-middle class (the top 40 percent) while the poorest 40 percent would get less than 21 percent of the total. (The middle 20 percent of households would get a roughly proportionate 21 percent of the benefit.)
Most economists agree that a stimulus directed to low-income households will generate a bigger spending impact than one aimed at higher-income households since affluent people are more likely to save the money, rather than plow it back into the economy. In assessing the relative merits of various stimulus approaches, the Congressional Budget Office recently gave high marks for cost-effectiveness for a tax rebate "focused on people who are likely to spend it." And none other than Federal Reserve Chairman Ben Bernanke urged that any fiscal package should be "efficient, in the sense of maximizing the amount of near-term stimulus per dollar of increased federal expenditure."
With the widest income gap in the nation, New York State has large shares of both rich and poor households. A tax rebate that reaches low-income people is more likely to stimulate New York's economy than one aimed at the rich for the simple reason that low-income households are more likely to spend all or most of their rebates than households at the high end of the income spectrum. One important caveat, though: To boost the economy, the money has to be spent on goods and services produced in the United States. If it goes toward the purchase of imported products, the economic benefit largely will "leak" out of our economy.
Ideas from the Senate
Any plan will have to win approval from the Senate, some of whose members have other thoughts on how to stimulate the economy. New York Sen. Charles Schumer, chairman of the Joint Economic Committee, said over the weekend that the Senate was likely to add an increase in unemployment benefits to the Bush-House stimulus plan. Greater spending on unemployment benefits would generate "more bang for the buck," said Schumer.
Unemployment insurance is a major "automatic stabilizer," providing partial income replacement for workers who lose their jobs. Most proposals for increasing unemployment benefits involve having the federal government fund benefits beyond the 26 weeks of payments financed through state unemployment funds. This would help New York State since 85,000 New Yorkers will exhaust their state unemployment benefits in the first six months of 2008, according to the National Employment Law Project.
An increase in food stamps to boost spending by low-income households is also actively being considered in the Senate, according to Schumer. Food stamp benefits go almost entirely to households subsisting below the federal poverty line. With rising food prices and reports that many low-income households run out of food by month's end, increasing the monthly allotment would both help low-income households and the economy. Over 1.8 million New Yorkers receive food stamps, including 1.1 million in New York City.
Support for increased unemployment and food stamp benefits crosses the aisle as Republican Senators Susan Collins and Olympia Snowe of Main have pledged to add funds for these benefits, and a bipartisan coalition of Northeastern and Midwestern senators will push for additional heating assistance for the poor. At a Senate hearing January 24, Peter Orszag, director of the Congressional Budget Office, testified that increases in unemployment benefits and food stamps would have a more immediate impact on the economy than tax rebates. "Food stamps and unemployment benefits can affect spending in two months, (while) rebates would affect spending at the end of 2008," he said.
Republican Governors Want Relief
The sagging economy, particularly the housing slump, has already started to be a serious drag on state and local government budgets in many parts of the country. If state and local governments, facing a decline in tax revenues, cut spending or increase taxes, that could further contract the economy. Columbia University's Joseph Stiglitz, winner of the 2001 Nobel Prize in Economics, has urged that any federal stimulus include fiscal relief to state governments. States don't have the luxury the federal government has in that states have to balance their budgets. The housing crash and economic slowdown are already forcing states to "respond by cutting spending, and this acts as an automatic destablilizer," Stiglitz wrote. Federal help could forestall those cuts.
Among others, Republican governors from California, Florida and Minnesota, have called for a temporary increase in the federal share of Medicaid expenditures to help them deal with yawning budget gaps. (Federal and state governments share the cost of providing health care to low-income Americans.)
To counter the prolonged economic weakness coming out of the 2001 recession and the accompanying fiscal pressures on states, Washington enacted $20 billion state fiscal relief stimulus package in early 2003. Half was used to increase the federal matching rate for Medicaid, and half was provided in the form of flexible grants to the states. Given the size of New York's Medicaid program, the increase in the federal Medicaid matching rate was particularly beneficial to New York. Every dollar of federal aid keeps a dollar of spending in the economy rather than forcing cutbacks or tax increases to maintain services and spending.
Increasing spending on public works like roads, schools and other facilities is often considered a way to prime the economic pump. In their $140 billion federal stimulus proposal released earlier this month, the Economic Policy Institute recommended $40 billion to accelerate public infrastructure repairs. Because infrastructure spending would speed up needed investments that support long-term economic growth and are less likely than other kinds of expenditures to “leak” out of the U.S. economy through the purchase of imports, many economists -- and some senators from both parties -- argue that a significant infrastructure spending plan warrants inclusion in any stimulus package.
Mortgage Foreclosure Relief
The depressed state of the housing market could retard the economy's ability to recover. Normally, sharply declining interest rates induce first-time homebuyers to take out mortgages and then spend money on furniture and appliances for their new homes. This time, though, the decline in interest rates might not have that effect. After years of over-heated expansion, the housing slump is likely to continue for some time. Plus, tens of thousands of homeowners saddled with unaffordable sub-prime mortgages will lose their homes through foreclosure, keeping prices and expectations down, slowing any rebound in the real-estate market.
Housing plays a key role in the national economy and shapes consumer expectations, making it essential that the government take action to stave off an epidemic of foreclosures and help the housing market recover. Government actions proposed so far, though, do not appear sufficient to turn around the market.
Just because New York City has not yet seen real estate values plummet does not mean that mortgage foreclosures are not a huge problem. Reckless and unregulated sub-prime lending has been widespread, particularly in neighborhoods of color in Brooklyn and Queens. Data from the Federal Reserve Bank of New York indicate that 20 percent of adjustable rate sub-prime mortgages made in New York City are already in foreclosure with more on the way. The economics consulting firm Global Insight predicts that there will be 50,000 foreclosures statewide in 2008 and that home values in New York will fall by $63 billion this year.
Turning the Economy Around
By itself, a federal stimulus package, even if modified in the Senate to provide more immediate and better distributed relief, probably will not resurrect economic growth. But a timely and targeted stimulus package is essential to significantly moderate some of the current downward economic pressures. The economy nationally and in New York will benefit to some degree. A smart fiscal stimulus package that boosts spending could provide an important complement to the aggressive monetary policy moves taken by the Federal Reserve over the past two months to ameliorate the credit squeeze and the decline in the housing market.
Fiscal stimulus would remove some of the burden on the Federal Reserve to bring down interest rates. Former Treasury Secretary Lawrence Summers notes the risks inherent in a policy of "excessively" low interest rates: downward pressure on the dollar likely to fuel inflation and another speculation-induced bubble.
As the home of Wall Street with its out-sized economic role, New York's long-run economic fate also depends on a new regulatory regime that will restrain Wall Street's bubble-making tendencies. Long-time financial market sage Henry Kaufman recently called for a thorough-going regulatory review of what went wrong on Wall Street. The current financial turmoil underlies once again, the need for New York City and the state to develop a set of policies to diversify the local and state economies and need to create more sustainable, good-paying jobs.
James Parrott is deputy director and chief economist of the Fiscal Policy Institute (www.fiscalpolicy.org). He has been studying and writing about the New York economy since he landed in New York City a quarter century ago.Â