The economics profession is deeply divided about the usefulness of fiscal policy. While few doubt that tax cuts and increased government spending can spur growth, critics say that politicians are likely to opt for worthless pork rather than measures that do the most for the economy.
That may be true. But with the economy turning sluggish, there are two possibilities for effective fiscal stimulus that might get the vote of both politicians and economists. First, the federal government could boost transfers to the states to head off looming budget cuts. Second, Congress could beef up the tax benefits for business investment that were enacted in March, 2002.
Together, the measures could inject $50 billion or more into the economy--enough to keep the recovery on track. They also address two big problems--state budget reductions and lethargic capital outlays. Caught in a crunch, state governments are slashing spending in a way that will hurt growth. And cash-strapped companies need all the help they can get to pay for capital spending.
Certainly other proposals are on the table in Washington for pumping up growth. Republicans are talking about eliminating double taxation of dividends, for example, while leading Democrats have suggested such ideas as giving companies that hire next year a break on their Social Security contribution.
But focusing on funds for the states and tax cuts for business investment offers a lot more bang for the buck--and here's why. With revenues plummeting, state government budget deficits would run as high as $60 billion for the fiscal year ending in June, 2003, without spending cuts, according to the National Conference of State Legislatures--and by law most states aren't allowed to borrow to fund budget gaps. "This is the worst fiscal crisis of the states since 1972," observes Richard P. Nathan, director of the Nelson A. Rockefeller Institute of Government in Albany, N.Y.
As a result, economists are predicting that state and local governments will reduce spending by 2% to 3% over the next year, which could mean a decrease of at least $30 billion. The programs that will be hardest hit are Medicaid and higher education. Tax hikes are on the agenda as well; already 16 states have raised taxes, dragging down consumer spending.
Avoiding further tax increases and spending cuts at the state level will require added funds--perhaps enough to make up the $30 billion spending shortfall--from Washington. The funds could be directed to specific programs, such as Medicaid, or could be left to the discretion of the states. "If the federal government were to step into this crisis that the states are facing, it could avoid some of the counterproductive moves they are making," says Alice M. Rivlin, senior fellow at the Brookings Institution.
The other thing Congress should do is give companies a bigger first-year tax write-off on any equipment they buy in 2003--and set it up so that the benefits are higher if they make the purchases sooner rather than later. That would push companies to move more quickly than under current rules.
A tax break for 2003 spending would cut companies' financing cost by 6% to 8% next year--twice as much as under the current provision, says Kevin A. Hassett, an economist at the American Enterprise Institute. That translates into added capital spending of $30 billion to $40 billion. Such a break should overcome the natural hesitancy of managers amid lots of uncertainty. The key is to coax planned spending into the next quarter or two, creating the momentum the recovery needs.
These proposals may have political advantages as well. Pushing spending down to the state level appeals to both conservatives and liberals. And a limited tax reduction for capital spending could attract both Republicans and Democrats.
The economic wrangling over the virtues of fiscal policy may never be resolved. But in the real world, Congress has a chance to take steps that could help a struggling recovery.
Popper writes about the economy from New York.
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