Post's Effort to Contextualize Budget Costs Doesn't

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Thursday, 16 September 2010 05:14

The Washington Post tried to be helpful in putting various budget items in context by comparing different expenditures/tax proposals. Specifically, it compared the costs of the Bush tax cuts, President Obama's stimulus package, and the TARP. While the comparisons are useful, they are still misleading.

The article points out that the projected 10-year cost of the Bush tax cuts vastly exceeds the $787 billion stimulus package. It also points out that if the tax cuts are extended indefinitely then the government will be receiving lower tax revenue in eternity. 

While the piece is correct in noting that the lost tax revenue will far exceed the cost of the stimulus, it is important to note the timing. There is no plausible argument that the stimulus crowded out any private investment at all. In fact, by almost every reasonable account the stimulus led to increased private investment by boosting demand. In this sense there was zero economic cost to the stimulus.

There is no reason that the Fed could not simply buy and hold forever the debt used to finance the stimulus. This would mean that the stimulus would have effectively added zero to the nation's debt burden, since the interest on these bonds would be paid to the Fed and then refunded directly to the Treasury.

The story of the tax cuts is more mixed. As long as the economy is far below full employment levels of output, tax cuts could also be financed with debt purchased and held by the Fed. However, at some point in the next ten years presumably the economy will be closer to full employment. At that point, if the Fed were to buy and hold the bonds it would lead to inflation. In this case, the tax cuts would be added to the country's debt burden.

However, it is also worth a bit of caution in assessing the long-term impact of the tax cut. Whatever the Congress does in 2010 cannot bind future Congresses for all time. While it may be interesting to ask about the cost of a measure for a long period of time as a point of information, this Congress lacks the power to preserve the Bush tax cuts for eternity.

It is also important to note that the bulk of the cost to taxpayers from the TARP will not be the $66 billion call on the budget noted in the article. Absent the TARP and related measures, Citigroup, Goldman Sachs, Morgan Stanley, Bank of America, along with many other banks, would have gone bankrupt. The government likely would have ended up seizing them and then selling off their assets. 

This would almost certainly have resulted in a situation where the financial sector accounted for a much smaller share of economic activity. Before the crisis, the narrow securities and investment trust sectors accounted for 2.5 percent of private sector output. Thirty years ago these sectors accounted for about 0.5 percent of private sector output.

If the collapse of these financial institutions led this sector contract halfway back to its former share of the economy, then it would have reduced its drain on the economy's resources by an amount equal to approximately 1 percent of private sector GDP, or $120 billion a year. This would come to about $1.5 trillion over the next decade.

This cost will be born in increased demand for goods and services that will lead to inflation unless the government and/or the Fed take steps to reduce demand elsewhere. While this cost may be less visible than pulling taxes directly out of people's pockets, the net effect is the same, the rest of the country will have less money to support their living standards.