With the seemingly endless stimulus now coming out of Washington, it’s time to revisit the question of whether deficits matter. In recent weeks, I’ve seen lots of pundits say that government spending is virtually costless, as interest rates are close to zero. There are two flaws with this argument.
Before getting into these flaws, let me acknowledge than many concerns regarding budget deficits are overstated. These big deficits are not likely to lead to high inflation, and they are not likely to lead to default on the debt. So what are the actual concerns?
1. Deficit spending always involves opportunity costs. That’s even true in a Keynesian model where deficit spending magically boosts output so much that it’s self-financing. Whenever you spend money on X, there’s always the opportunity cost of not spending it on Y.
Is the government’s best use of money to send people like me a check for $1200? It’s hard to imagine that the answer is yes, even if you believe (like me) that the government is not very good at wisely spending money. Consider this analogy. Imagine you are Ms. Bezos, and you’ve just come into a windfall of $50 billion. You decide to give a big chuck of the money to charity. Where do you donate the money?
It’s probably true that the average middle class resident of Seattle would benefit more from a $1200 check than Ms. Bezos, but is that really the best use of the money? I don’t know of any charity that randomly hands out checks to average people.
Even if you favor tax cuts as the preferred way of returning money to the public, giving almost everyone a $1200 check is not really a tax cut, it’s a (welfare) spending increase. A tax cut is when you lower the tax rates from which you derive the money in the first place. Taxing people and giving part of the money back is a tax program combined with a spending program. To argue otherwise is to argue that AFDC welfare and Social Security are “tax cuts”.
If we must run deficits, then they should be either in the form of cuts in tax rates or spending in areas where it has the greatest impact on human wellbeing. And that’s probably not a huge bailout of the Post Office.
2. The second cost of budget deficits is the future tax burden they impose. Public finance theory suggests that the most efficient policy is one that smooths tax rates over time. Notice that even this criterion suggests that we should dramatically increase the budget deficit during wars and depressions. So right now it is appropriate to increase the budget deficit somewhat. (And we should have run a budget surplus in 2019, when the actual deficit was exploding upward.)
Nonetheless, it’s highly likely that the deficit this year will be too large, even from an optimal public finance perspective. I expect we’ll have to pay a price in terms of higher future taxes, perhaps not too far out in the future. Yes, higher future taxes were already on the way, for various reasons, but the current deficits will make the tax increases even greater than otherwise.
PS. I’m also seeing pundits suddenly claiming that unemployment insurance doesn’t discourage people from working. And yet even progressive bloggers like Brad DeLong and progressive textbook writers like Paul Krugman suggest just the opposite. If you make something more lucrative, you will get more of the activity that you are subsidizing.
I happen to believe that some expansion of unemployment insurance was appropriate during this pandemic, especially the provisions that covered a wider range of workers. But we shouldn’t pretend that this does not increase joblessness. And I don’t understand why unemployment was made so generous that it replaced more than 100% of lost wages. Can someone explain the logic of that to me?
The science of economics always regresses during a depression. We saw that in the 1930s, in the 2010s, and we are seeing it again today.
READER COMMENTS
Daniel Carroll
Jul 22 2020 at 2:34pm
They didn’t want people to work if they didn’t have to. That’s the point of a stay-at-home order.
Thomas Hutcheson
Jul 23 2020 at 9:34am
Why wouldn’t giving all workers 90% of lost income plus health insurance worked better than an across the board top up?
Dylan
Jul 25 2020 at 10:11am
Probably because we don’t have the systems in place to do it?
https://www.npr.org/2020/07/25/895212697/state-unemployment-agencies-could-take-months-to-adapt-to-wh-proposal-memos-show?utm_medium=RSS&utm_campaign=news
Dylan
Jul 22 2020 at 2:47pm
I’ve mentioned this a number of times on this site, and I’m not the only one, but based on comments from legislators at the time of passing the act, this was BY DESIGN. A generous UI means people aren’t incentivized to look for work or be forced to take more risky jobs because they need the money. That’s considered a feature not a bug if your goal is to keep people from leaving the house.
You can disagree that this is a wise goal, but it was undoubtedly the goal when the UI was originally passed.
I think it is also fair to disagree with how they went about it. There were surely better targeted policies that could have got money to those most at need at a much lower costs, but that’s not the kind of thing that Congress is good at doing in the best of times, and certainly not during an emergency. Much easier to just send money to everyone and worry about the fallout when it is someone else’s problem.
Scott Sumner
Jul 22 2020 at 5:10pm
That may be. However, many people in Congress want to extend the extra $600. Is the goal to keep them unemployed for many more months? That seems odd.
A K
Jul 23 2020 at 7:17am
I think the logic is that based on whatever data has come out, the unemployment rate continues to fall and people aren’t going into poverty en masse, so giving a high unemployment benefit has no negative effects. Ergo, UBI forever.
The crucial element that’s being left out is that everyone knows that the boosted unemployment would only last for a few months; so, the impetus to get a job is still there, it’s just that the time spent searching for a job will be more comfortable. In my opinion, I don’t think instituting a permanent high unemployment benefit or UBI of this price would work at all because of the disincentivize.
Matthias Goergens
Jul 23 2020 at 7:46am
Unemployment benefits and UBI are quite different.
As typically understood, a UBI would be paid even when you have a job.
Thomas Hutcheson
Jul 22 2020 at 4:32pm
I agree that it would be better to replace the unemployment top up and the PPP with a proper UI scheme that replaces a set percentage of lost compensation (including the cost of health insurance unless that is handled automatically through ACA). And this would be a good time to eliminate the capped wage tax that is paid into the SS and Medicaid trust funds and replace it, when the Fed decides to return us to full employment, with a VAT.
Jeff B
Jul 22 2020 at 5:03pm
Take with a grain of salt, but I had heard in some instances it was because they could not re-program the unemployment systems to cap at the person’s normal income?
Hopefully it isn’t that bad, though given the news about inability to find COBOL programmers to try to handle the huge increase in demand on the system — I would not be completely surprised by it.
Scott Sumner
Jul 22 2020 at 5:11pm
Unfortunately, I could believe something like that is possible. It’s one of many reasons why I’m a libertarian. Large governments are extraordinarily incompetent.
Lorenzo from Oz
Jul 23 2020 at 10:39pm
Extraordinarily incompetent from a public benefit perspective. Very competent at sucking up resources. What they are functionally selected to do, as distinct from notionally intended to do, they do quite well.
Michael Pettengill
Jul 27 2020 at 5:18am
The 50 States are generally not “big government” in they lack the capital of businesses of equal size in assets and labor.
And the more conservative the State, the economic theory seems to be that slashing consumer spending, and defaulting on consumer debt, is the best way to get businesses to hire workers.
The objection to the expiring plan is consumers paying at least $600 a week on debt, rent, food, etc is damaging the economy, and they should be spending less and defaulting on debt.
Of course, the $600 a week is theoretical because a half dozen States haven’t been able to pay any benefits provided by the law months ago.
Mark Barbieri
Jul 22 2020 at 5:08pm
If we’re going to do another round of “stimulus”, make it in the form of loans. Let people borrow another $1,200 to be paid back in their taxes over 5 years with a reasonable rate of interest. Call it a tax refund advance or something. The stimulus money is going to be borrowed money one way or another, so what could be more fair than having the recipients pay it back? And that would help insure that it is targeted to those that need it most. If you want to make it more progressive, work out a deal so that the amount paid back is reduced to the extent that your future earnings are below some low threshold.
Whatever you do, don’t send money to dead people again and then demand that their heirs figure out how to pay it back. Have at least some sense of decency.
nobody.really
Jul 22 2020 at 6:24pm
Easy for you to say. In Chicago, dead people are a substantial portion of the electorate. What politician wants to risk the wrath of that voting block?
Walter
Jul 23 2020 at 12:10pm
This from the guy that complained for a decade that we didn’t print enough money during the great recession.
Scott Sumner
Jul 23 2020 at 3:21pm
Yes. That’s right.
Lorenzo from Oz
Jul 23 2020 at 10:41pm
Because different downturns have different causes, which may require different responses.
One of the reasons that forward economic indicators have held up quite well is there is utterly no mystery as to the nature of the current economic shock. That means, in an important sense, it is much less of a shock.
Henry
Jul 23 2020 at 9:28pm
First, let me state that my understanding of economics is very rudimentary.
This is not the first downturn in the economy. Ten, twelve years have passed since the previous downturn. Several steps, such as TARP, were taken at that time. Is there a consensus on whether the Bush/Obama steps were right? Would some alternative actions have led to a better recovery? What were the big policy successes? What were the big failures? What lessons should we apply today?
Lorenzo from Oz
Jul 23 2020 at 10:45pm
Utterly off topic, but I posted an essay that, while a critique of Marcel Mauss’s famous essay The Gift, has something to say about matters monetary.
There is even a reference to the Chinese tributary trade system. And money illusion.
It is an attempt to talk about the origins of money in a way both economists and anthropologists can be comfortable with.
Michael Sandifer
Jul 25 2020 at 8:46am
This is not to mention that during a recession, to the degree the cause is nominal, the lower interest rates aren’t lower in a real sense, because the value of the unit of medium of exchange has increased versus output.
Michael Pettengill
Jul 27 2020 at 5:05am
The Keynesian model is not Keynes policy,, but as best as I can tell a conservative fiction.
Keynes rejected handing out cash.
Instead, in a time of unused labor, he proposed building capital, private ideally, but otherwise public capital.
If borrowing to build capital is bad, then there should be no banking to allow individuals to run deficits of 4-10 times income to build a house, or businesses to run massive deficits to start by building their first factory.
Building capital can only be done by paying workers which puts money in consumer pockets without government, or private handouts.
FDR likewise agreed and promoted home production for females, which in this case could be sewing PPEs at home and paid per unit.
One very needed capital investment is fiber to every address so every address would have Internet sufficient to do video conferencing at $40-50 a month, 25megabit up/down. Telco profits would come from selling 50, 100, 1000 megabit over the same fiber, which would allow big computation users to be located anywhere, instead of being forced into dense real estate. This would be FDRs rural electric and telco push by loans to coops which repaid the debt over time from customer rates.
Bob Murphy
Jul 27 2020 at 7:40am
Scott, when you say that even DeLong and Krugman acknowledge that UI extensions destroy jobs, are you aware of the latter’s…nuance? Check this out in case you missed it.
Larry
Jul 27 2020 at 7:52pm
The “argument” I heard was that The higher amount is was how much workers “should” be making and that if your workers didn’t want to come back at their old pay, you should raise them to match the subsidy.
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