- Fiscal stimulus hasn’t been used to break the US out of its post-global financial crisis malaise of low growth, low investment, and low inflation.
- President Biden’s approach breaks significantly with fiscal packages pursued by Bush, Obama, and Trump.
- Stimulus directed to lower-income households will be spent rather than saved, while large-scale infrastructure investment can put idle resources to work.
- George Pearkes is the global macro strategist for Bespoke Investment Group.
- This is an opinion column. The thoughts expressed are those of the author.
- See more stories on Insider’s business page.
For nearly more than a decade, the US economy has been stuck in a low growth, low inflation, and low investment malaise that emerged after the global financial crisis. Despite myriad attempts from three presidents and a bevy of lawmakers in Congress, no fiscal action has been able to break the US out of this funk. But now, President Biden’s plans have a chance to finally do just that.
The recently-enacted American Recovery Plan (ARP) stimulus and the forthcoming Build Back Better (BBB) infrastructure package represent a fundamental change in how fiscal policy operates. This change could finally spark a change in the trend of consumer spending, total output, and more robust inflation that policymakers have sought in vain.
Fiscal policy’s fumbles
This isn’t to say that previous administrations haven’t tried to kick the economy into gear with some sort of stimulus or federal spending. But those previous attempts were either too restrained or totally misdirected.
During the Bush Administration, the US Treasury did send out stimulus checks to American households, but the overall size of the Bush stimulus in early 2008 was too small to avert the ongoing housing collapse and resulting.
The Obama Administration’s American Recovery and Reinvestment Act of 2009 didn’t include significant direct payments to taxpayers and spent just $111 billion on infrastructure, spread across a range of direct purchases, grants, and tax incentives.
Republicans’ surge in the House in the 2010 elections ended any chance of further direct stimulus, and the US entered a period of slow and grinding austerity — cuts to federal spending and little support for the economy — that was a steady brake on the recovery from 2011 onwards.
Then came President Trump, who introduced a package of tax cuts that started to widen the federal deficit. Some mainstream economists fretted at the time that the Tax Cuts and Jobs Act might kick off an inflationary spiral, driving prices higher and higher.
While the $1.5 trillion price tag on Trump’s tax cuts with relatively little spare economic capacity could have had an impact on the overall economy — unlike Bush and Obama efforts at stimulus that were relatively small versus slack economic capacity — it was never going to kick off a virtuous cycle of higher demand that drives real growth, investment, and inflation.
The reason was who the tax cuts benefited. The Tax Policy Center estimated households in the bottom 80% of the income distribution would see an income boost of 2% or less from the cuts, while higher income households reaped larger benefits.
That was a huge problem, because higher income consumers spend a much smaller share of their income gains than lower-income consumers. In the chart below, I show the increase in dollars spent as a percentage of after-tax income by decile of pre-tax income over the 5 years from 2014 to 2019. That is, for every additional dollar in income that a household received how much of it went back out into the economy as new spending?
As shown, consumers in the bottom half of the income distribution on average raised spending more than their increase in incomes over the five year period. Conversely, the highest 10% of earners raised spending by less than half as much as their increase in income. Basically, as low-income households get more cash, they tend to spend it on things they need — in turn boosting the economy. By comparison, high-income households save most of that increased income.
Economists call this “marginal propensity to consume”, or MPC for short, and the implications are clear: if you want to generate economic activity via consumer spending, you’re far more likely to do so by giving more income to lower-income households.
A practical example may be helpful. A $1000 tax cut for the top decile would lead to roughly $470 in new consumer spending, all-else equal. For consumers below the median, it would lead to more than $1000 of new consumer spending.
An ambitious attempt
While the Trump tax cuts barely benefitted low-income households — and thus stifled any chance of a real economic boost — the ARP does just that. Tax Policy Center estimates suggest the $1.9 trillion package will raise the income of those in the bottom 20% of the income distribution by a staggering 20%. By contrast, the top quintile of earners sees a scant 0.7% gain.
From an MPC perspective, the ARP isn’t just large. It’s also highly likely to generate substantial economic activity via consumer spending because of who it benefits. That makes it unique among fiscal packages over the last several presidential administrations.
Earlier this week, reports started to circulate that the Biden Administration is also eyeing as much as $3 trillion in spending with investments in manufacturing, transportation infrastructure, clean energy, rural broadband, and housing, as well as further transfers to households via free community college, universal pre-kindergarten education, and subsidies for child care.
While this would also likely be coupled with higher taxes on corporations and the wealthy — and therefore be smaller from a simplistic budget deficit perspective — it still represents large increases in government spending on specific goods and services that were missing from prior fiscal plans passed over the past couple of decades.
The combination of huge stimulus for low-income consumers and material government spending to mobilize real resources make Biden’s fiscal approach a big shift from recent history. It’s too early to have confidence that the plan will boost US economic growth to its stronger pre-2000 trend (as I’ve discussed previously), but the basic approach of scale and design give Biden’s bills a far better shot than other recent attempts by Democrats and Republicans alike.