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The Obama Stimulus: An $825 Billion First Step

by James Parrott, Jan 22, 2009
 


For More on Helping New York's Economy

Paying Attention to Cities By Jonathan Bowles
After years of federal policies neglecting urban areas, Barack Obama has sent some encouraging signals that he understands their importance. Certainly, New York could use a helping hand. The director of the Center for an Urban Future lays out some ideas for what the president could do to aid New York.

Using the Crisis to Prevent the Next One By J. Mijin Cha
The current turmoil can help us reduce our dependence on Wall Street and create good "green collar" jobs that help fuel a resurgence of the middle class. The director of campaign research at the Urban Agenda explains how.

Infrastructure Investments that Make Sense By Carter Craft
As big as the stimulus package may be, the country has to invest the money wisely. An urban planner offers some novel ideas for New York projects -- from recycling grease to ferries for freight.

From Gas-Guzzling Cars to Clean Buses By Charles Stone
Simply lending funds to struggling auto companies won't spur economic growth. Instead, an economist suggests, the government should create a voucher program to deploy the resources of the auto companies, spur investment -- and help the environment.

Previous Articles
A Federal Stimulus for City Parks By Anne Schwartz
Advocates hope that President Obama and Congress will recognize that funding parks would not only improve the quality of life and the environment but also spur investment and raise real estate values.

Stimulus Money: The Downturn's Silver Lining? By Graham Beck
The stimulus package could offer more federal funds for transportation projects. The MTA is making its list, but there are sure to be lots of restrictions -- and competition.

The version of the American Recovery and Reinvestment Plan unveiled on Jan. 15 by House Democrats is breathtaking in its scope and cost. Intended to retain and create 3.7 million jobs over the next two years, the $825 billion package of federal government investments includes dozens of spending measures ranging from $200 billion in fiscal relief to help state and local governments, to $6 billion to extend broadband to rural areas, a 21st century version of Depression-era rural electrification. Two thirds of the total value consists of spending, with one third for tax cuts.

Negotiated with President Barack Obama's transition team, the plan - a.k.a. Stimulus II or ARRP - is an important first step to halt the downward economic spiral triggered by last fall's financial meltdown. As large as it is, though-5 percent of gross domestic product-it is not sufficient to create a sustained recovery. Two other steps are essential. First, more dramatic action is needed to put the brakes on the collapsing housing market. Second, making a recovery sustainable will require a set of policies to lift wages and bolster the middle class. Without these two complementary steps, ARRP might provide temporary relief for our economic illness but not a cure.

Helping the States

Whatever its limitations as a long-term solution, ARRP will provide much-welcome short-term budget relief for New York and other states (45 states face budget gaps). The plan will increase the federal share of Medicaid spending and provide billions in education aid to states and school districts. Both of these measures will help to moderate the severe budget cuts proposed by Gov. David Paterson. New York State should receive upward of $10 billion - and possibly as much as $15 billion - over two years -- funds that will help close the state's budget gaps. Such federal relief will help states maintain their spending and prevent spending cuts or tax increases, both of which would have intensified the downward economic spiral.

Help for a Teetering Economy

A year ago, Congress and the Bush administration agreed to a $150 billion stimulus package that consisted largely of tax rebates. Most economists now agree that last year's stimulus was not up to the task because tax cuts provide less "economic bang for the buck" than most other forms of stimulus. Economic forecaster Mark Zandi, a former advisor to presidential candidate John McCain, estimates that every dollar in tax cuts generates only $1.01 in economic activity, much lower than the spending impact of increasing unemployment compensation ($1.63), state fiscal relief ($1.38) or spending on infrastructure ($1.59). Also, since the tax rebate checks were sent out in May and June, when gasoline prices were skyrocketing, many recipients spent the money to cover their gas costs.

The magnitude of a proposed second stimulus has mounted steadily since last September's financial market meltdown and the ensuing sharp collapse in the consumer spending that accounts for 70 percent of demand in the economy. The spending collapse was compounded by a credit market freeze as Wall Street firms and banks confronted a mountain of bad debts created by high-risk lending and unregulated gambling. The crash of the housing and stock markets destroyed literally trillions in home equity and retirement savings held by millions of middle class households. Along with steadily mounting job losses, this caused households to sharply reduce spending. The collapse of consumer spending is thought to have pulled GDP down by as much as 5 percent during the fourth quarter of 2008.

It is no exaggeration to say that this is the worst economy since the Great Depression. The 2.6 million jobs lost in 2008 were more than in any year since 1945. Overall unemployment could be 9 percent by the end of the year and 11 percent in 2010 in the absence of the recovery plan, according to economist Zandi. Already, unemployment among adult black men is 13.4 percent. Housing prices have fallen 25 percent on average. There were 2.25 million home mortgage foreclosures last year, and one out of every six homeowners owes more on their mortgage than their house is worth.

What Stimulus II Would Do

The proposed American Recovery and Reinvestment Plan is a 21st century version of a government-led recovery and investment program, combining some of the best elements of the Depression-era Works Progress Administration, the Eisenhower era commitment to build the Interstate Highway System, the Apollo Project, and the Great Society. The plan includes spending that will not only provide some short-term stimulus but will increase the long-term productive capacity or efficiency of the economy.

One of the biggest components is $52 billion for various "green jobs" programs from weatherizing public buildings (see related story) and homes to reduce energy demand, to developing a "smart" electric power grid that is both more reliable and better able to transmit clean, renewable energy.

The package would also create jobs by spending $67 billion for infrastructure. Because of the urgent need to boost jobs as quickly as possible, it emphasizes "shovel ready" projects, including mass transit systems, highways, bridges, airports, national parks, water and sewer systems, flood control, and environmental cleanup. The Metropolitan Transit Authority will be able to use some of these monies to fund some of the construction projects and equipment needs in its capital budget. Governor David Paterson submitted an extensive list of 1,922 "ready-to-go" projects to the Obama transition team.

This second stimulus package provides $12 billion to support forward-looking research and development investments that could be particularly important in the future, including biomedical, climate change and alternative energy research, and funds to modernize and expand government and university research facilities.

The ARRP includes $5 billion for job training and employment services, including $1.2 billion to create 1 million summer jobs for youth. It offers additional -- and substantial funds -- for worker training and education as part of the education, healthcare, and science and technology initiatives. There is $5 billion for early childhood development, including additional slots in subsidized childcare and Head Start.

A particularly critical part of ARRP is aid to the unemployed. The program includes $36 billion to extend and modestly increase unemployment benefits, and incentives to encourage states to expand unemployment insurance coverage for low-wage and part-time workers. An additional $30 billion would subsidize health coverage for unemployed workers and provide 100 percent federal funding (i.e., dropping the requirement for a state match) for two years for Medicaid-eligible workers who become unemployed.

Nearly $30 billion would go to increase food stamps, low-income heating assistance, assistance provided under federal Supplemental Security Income, aid for the homeless and Temporary Assistance for Needy Families block grants. A total of more than $11 billion would fund repair and modernization of public housing, help communities build and rehabilitate low-income housing using green technologies, and enable communities to purchase and rehabilitate foreclosed and vacant properties.

Stimulus II and New York

New York's unemployed workers, their families, the state government and local governments and the broader New York economy will benefit significantly from this much-needed and unprecedented economic recovery plan. New York, though, must make sure that the billions of federal dollars it will receive for infrastructure, energy development and other projects lead to the creation of good jobs that provide decent wages, benefits and career development opportunities. This plan also presents New York with a golden opportunity to develop a strategic plan to revitalize the upstate economy and help the downstate economy adjust to a permanently smaller role for the finance sector.

Stopping the Housing Collapse

The Obama team has suggested ways to use some of the remaining funds from the $700 billion Emergency Economic Stabilization Act, the so-called "bailout" that was passed in early October, to address the housing crisis. In a Jan. 15 to Congress, Larry Summers, who is to be director of the National Economic Council, indicated the new administration would commit $50 billion to $100 billion to "reduce the number of preventable foreclosures," reform bankruptcy laws, revamp the modest Hope for Homeowners program, and require banks receiving bailout assistance to "implement mortgage foreclosure mitigation" programs.

These measures can only help but may well not be sufficient to ensure that banks renegotiate mortgages on the scale necessary to halt the slide in housing prices. Until that happens, housing prices may fall further and the value of the mortgages and mortgage-backed assets that dominate the balance sheets of the major financial institutions will remain questionable. Investor's suspicions about the "toxicity" of these assets have paralyzed credit markets for most of the past year.

Originally, the $700 billion financial "bailout" was supposed to take those toxic assets off the hands of the banks, under the Trouble Asset Recovery Program or TARP. Some of the remaining $350 billion could be used for this. Now, though, the incoming Obama administration appears to be considering whether to provide another round of massive funding ($1 trillion or more) to salvage bank portfolios.

Given the magnitude and character of the federal interventions so far, the banking system already has been effectively nationalized and is "private" in name only. While the government has allowed bank executives to remain in control, at some point, Washington leaders will have to decide whether taxpayers might be better served by completing the nationalization of the banking system rather than trying to revive banks that have impaled themselves on massive amounts of toxic assets. To date, the overall magnitude of taxpayer resources pledged to financial market rescue can only be described as "galactic" -- $7 trillion to $8 trillion in capital infusions, low-interest loans and federal guarantees.

Boosting the Middle Class

Along with the dual collapse of the housing and financial markets, the middle class squeeze played a major role the current economic precariousness. Wages have not kept pace with productivity or with the health and retirement security costs employers have shifted to workers. As a result, the average working family has been forced to take on substantial home equity or credit card debt in recent years to try to maintain living standards. The absence of a firm foundation for middle class prosperity meant that economic growth from 2003 to 2007 was possible only because of the economy's bubble tendency and the excessive reliance on borrowing at every level.

Boosting the middle class through higher wages and increased economic security involves such things as passage of the Employee Free Choice Act that will remove barriers imposed by the current labor law system that frustrate workers' efforts to join unions.

The American Recovery and Reinvestment Program is an essential step for the U.S. to take in pulling the economy out of this historic slump. As the House leadership's version of ARRP is negotiated in the House and with the Senate, it is critical that the provisions aiding states and low-income populations remain the centerpiece and that any business tax cuts be limited. To achieve a balanced and long-lasting prosperity, however, other actions will be needed to resolve the housing crisis and to rebuild the middle class. Without such policies, the recovery and reinvestment plan might create a short-term rebound but one that will fizzle out after two or three years.

The new administration gives every indication that it is aware of the need for these complementary actions. Time will tell whether it can achieve initial success on the economic recovery front and build the political support to turn recovery into sustained prosperity.

James Parrott is deputy director and chief economist of the Fiscal Policy Institute. He has been studying and writing about the New York economy since he landed in New York City a quarter century ago.


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