CBPP: Correcting Five Myths About the Stimulus Bill

by James R. Horney, Nicholas Johnson, and Lawrence J. Haas

July 10, 2009

Some critics of the economic recovery law (or “stimulus” bill) that President Obama and Congress enacted early this year are mischaracterizing how it was supposed to work and what it was supposed to do. For instance, some critics complain that, because unemployment has risen in recent months, the law is not working. Others claim that states are improperly using the money to close budget shortfalls or finance short-term projects.

These and a number of other criticisms are off base. The law – officially the American Recovery and Reinvestment Act – is working as intended and, without it, the economy and the job prospects for many Americans would be worse. The $787 billion in new spending and tax cuts was supposed to slow the economy’s downward spiral and then help it recover over time from what will be the nation’s deepest recession in decades, if not since the Great Depression of the 1930s. The law was designed to save and create more than 3.5 million jobs over the next two years, according to the Obama Administration, and to help states close their budget shortfalls so they could avoid even greater spending cuts and larger tax increases than they are already enacting to meet their balanced budget requirements.

Here are key points to keep in mind about the recovery law:

1: The recent rise in unemployment does not mean the law is not working.

No mainstream economist believed the law would immediately revive the economy and cause unemployment to begin falling. In addition, at the time Congress enacted the law, virtually all forecasts in both the public and private sectors underestimated the severity of the downturn. Nevertheless, the law has slowed the decline and will help the turnaround occur sooner than it would have otherwise.

• “[I]f policymakers had not been able to pass a stimulus plan, real GDP would have declined nearly 6% in the second quarter and by more than 3% in the third,” Economist Mark Zandi of Moody’s Economy.com wrote last month. “With the stimulus, GDP is expected to fall close to 3% in the second quarter and rise a bit in the third.”[1]
• Similarly, the Congressional Budget Office (CBO) concluded in March that “Although the economy is likely to continue to deteriorate for some time, the enactment of the American Recovery and Reinvestment Act and very aggressive actions by the Federal Reserve and the Treasury are projected to help end the recession in the fall of 2009.”[2] CBO stated that, “without such stimulus, the economy probably would have continued to contract sharply throughout 2009”[3] and its enactment “boosts real GDP relative to that in a forecast of what would have happened in the absence of stimulus by about 2 ½ percent in the fourth quarter of 2009 and by about 2 ¼ percent in the fourth quarter of 2010.”[4]

The continuing deterioration in the job market was expected as well. As CBO Director Douglas Elmendorf observed in May, “labor market indicators tend to lag changes in economic activity. The pattern of past recessions suggests that employment will not increase and the unemployment rate will not decline until 6 to 12 months after output begins to increase again.”[5] CBO has projected that, even with the recovery law, unemployment will continue to rise at least through the end of this year.

But here, too, the recovery law has had a positive effect.

• “[T]he stimulus results in approximately 2.5 million more jobs by the end of 2010 than would have been the case without it,” Zandi wrote, “and leaves the unemployment rate almost 2 percentage points lower.”[6]
• CBO has stated that, because of the law, “the unemployment rate [in its forecast] is lower than it would otherwise be by about 0.9 percentage points in the fourth quarter of 2009 and 1.3 percentage points in the fourth quarter of 2010. The boost to total employment peaks at about 2 ½ million jobs in the second half of 2010.”[7]

2: The Administration and Congress expected the stimulus money to be spent gradually over the next two to three years, and what’s been spent to date is stimulating the economy and helping millions of Americans.

CBO estimated that one quarter of the recovery-law spending would occur in fiscal 2009,[8] and has said that the funds already expended have helped strengthen the economy. In late May, Elmendorf stated that “the rate of spending [for the stimulus bill] is broadly consistent with the assumptions that CBO used to estimate the macroeconomic effects of the legislation. Under those assumptions, ARRA will boost the level of GDP by the end of this year by between 1.4 percent and 3.8 percent….”[9]

The law “is currently bolstering disposable income,” Elmendorf said. “Specifically, lower payroll tax withholding resulting from that legislation began in March and was fully phased in on April 1, and unemployment insurance benefits have been increased.” [10]

In addition, states have used $15 billion through June 29 to avoid cuts and cover increased caseloads in Medicaid, bolstering the health care industry (and providing care to people could not otherwise afford it). Higher benefits to 15.3 million families under what was previously called the Food Stamp Program (now the Supplemental Nutrition Assistance Program) pumped an additional $730 million into the economy in April. (Zandi estimates that every dollar spent on Food Stamps generates $1.84 in total economic activity.)

The temporary increase in unemployment benefit levels is providing another $940 million per month in help to jobless workers. Also, more than 2.5 million people are now receiving unemployment benefits due to provisions that allow unemployed workers to receive additional weeks of benefits when their regular unemployment benefits run out.

Finally, last January, Elmendorf made clear the desirability of making recovery-law funding available over a longer period than usual: “Because most periods of economic weakness are fairly short-lived, it is generally preferable that stimulus packages be short-lived. Currently, however, CBO projects that economic output will remain significantly below its potential for several more years, so policies that provide stimulus for an extended period of time may be appropriate. Indeed, a fiscal stimulus that ends before the economy has started to regain its footing runs the risk of exacerbating economic weakness when the stimulus ends.”[11]

3: The nation faces a very serious long-term budget problem, but the recovery law will exacerbate that problem only a very small amount.

Although the recovery law significantly increases short-run deficits, the fiscal effects of the bill over the long run are tiny. In January, the Center on Budget and Policy Priorities calculated that the recovery law would add just 3 percent to the budget shortfall through 2050. [12] That’s because the tax cuts and new spending in the law are temporary. The main driver of the nation’s long-term budget shortfall is ongoing factors, the most notable of which is steadily rising health care costs.

CBO projects that the law will increase the number of people with jobs by 2.5 million next year. In addition, millions of others will benefit from the higher incomes produced in an economy that is less weak than it otherwise would have been. The economy clearly needed the boost in demand that the new spending and tax cuts generate. Failing to provide this boost due to fear of very slightly increasing the long-term budget problem would have been foolish.

4: The law was specifically designed to help states close their budget shortfalls.

State revenues have fallen sharply due to the recession. As a result, states face a combined $350 billion in projected budget gaps over the next two years. Because states also face legal requirements to balance their budgets, they must enact program cuts and tax increases to close their budget gaps. Such measures, however, reduce demand for goods and services, making a weak economy even weaker. Without federal funds, states would have to take even more dramatic measures that, by reducing demand, would cost jobs and make the recession even more severe.

The recovery law is giving states roughly $140 billion over the next two years in Medicaid and education funding, reducing the $350 billion shortfall by that amount, helping states avoid some of the largest program cuts they were contemplating, and reducing the negative impact of their budget-balancing steps on the economy. Virginia, for example, reversed plans to end funding for hundreds of sheriffs’ deputies, thousands of school personnel, and three mental health facilities. New York reversed a major proposed cut to senior citizens’ prescription drug benefits and another major cut to school funding.

Other states are responding similarly, says a new Government Accountability Office (GAO) report. In at least eight states (out of 16 states studied), GAO found that increased education funding was helping local school districts keep teachers on the payroll who would have been laid off. “Overall, states reported using Recovery Act funds to stabilize state budgets and to cope with fiscal stresses,” GAO concluded. “The funds helped them maintain staffing for existing programs and minimize or avoid tax increases as well as reductions in services.” [13]

5: States are properly using stimulus funds for short-term projects.

In the recovery law, Congress required that states put their additional federal funds to work as quickly as possible, which in many cases means investing in existing projects and programs rather than mounting major new initiatives. That helps to achieve the goals of both stimulating demand for goods and services and of saving or creating as many jobs as possible, as quickly as possible.

In infrastructure spending, GAO found that many states are using recovery law funds for paving improvements and other projects that are “shovel ready” and can create jobs relatively quickly. Longer-term projects could require years of planning and would not create jobs as quickly. In education spending, GAO found that many states and school districts are using the money to avert elementary and secondary school layoffs, minimize tuition increases at colleges and universities, and address other immediate needs.