President-elect Biden has made no secret of the fact that, once in office, he is ready and willing to support a lot of new spending. Last week, he made good on his pledge, unveiling a $1.9 trillion “relief” package less than a month after Congress had passed a nearly $1 trillion pandemic-related stimulus measure.
In a speech announcing the details of the new package, billed as the American Rescue Plan, Biden noted that it will include $400 a week in extended unemployment insurance, $1,400 “stimulus” checks for all but high wage earners, a $15 federally-mandated minimum wage, 14 weeks of paid family and medical leave, and rent forbearance—to list just a few.
Before we assess the reasons why adding trillions of dollars more debt to an already huge mountain of debt is wrong, we should be mindful of just how much the government has already spent on “relief/stimulus” measures over the past 10 months. Tallying up the Families First Act, the CARES Act, Paycheck Protection Program loans, and the Response and Relief Act, the federal government has allocated about $4.5 trillion, of which $3.42 trillion will be entirely deficit-financed.
If Congress were to agree to spend an additional $1.9 trillion, we are looking at total stimulus spending over a one-year period of 31% of GDP, the vast majority of which would be deficit-financed. By comparison, during the four years following the 2008 financial crash, the stimulus bill under George W. Bush, the stimulus bill under Barack Obama and TARP combined accounted for about 10% of GDP at the time.
The Myth of the Spending Multiplier
And for what? The calls for sustained spending during a recession—in the form of unemployment checks, individual stimulus checks, small-business grants, shovel-ready projects and payroll tax cuts—rest on the idea of an all-powerful federal spending multiplier, or the idea that if the government spends one dollar, the economy will grow by more than a dollar. This argument ignores recent empirical evidence that the costs of increased government spending far outweigh the benefits to the economy.
For starters, contrary to the claims of government spending proponents, economists have not reached a consensus about the actual return on government spending. While some economists find that a dollar spent by the government generates more than a dollar in return, others find that the return is less than one dollar. And yet others find that if you take into account the future taxes needed to pay for the dollar that’s spent and the resulting loss of capital for use in the private economy, the multiplier is actually negative, and the economy takes a hit.
Our recent review of the academic literature reveals that most of “the empirical literature on fiscal multipliers conducted since  has found economic multipliers resulting from additional government spending ranging from a lower estimate of around 0.2 to an upper estimate of around 0.9.” We go on to explain that in “pulling the results from two dozen academic studies, we calculate an average multiplier at the low end of 0.31 and an average multiplier at the high end of 0.66.”
There are rare cases when government spending can stimulate the economy. But for that to happen, the environment in which the spending takes place, such as a situation involving sizable indebtedness, and the design and speed of the stimulus are important in its success. Unfortunately, the United States has the features of a country where stimulus by spending has little if any impact and, in fact, can have a negative impact on growth.
As so it was with the CARES Act. According to the Congressional Budget Office (CBO), the long-term cumulative growth resulting from each dollar of spending under the legislation was 58 cents. Not very stimulative. There is no reason to believe that the next round of spending, and the one after that, will be any different.
The Myth That Debt Doesn’t Matter
To make matters worse, federal spending is at unprecedented levels, and policymakers’ inability to break from this spending splurge cycle is going to have serious long-term ramifications. The economic fallacy of using low-trending interest rates to justify borrowing endless amounts of money is still very much alive and kicking. Some economists point to the downward trends in Treasury yields as a sign that there is no chance of a fiscal crisis—these economists make the naive assumption that trends cannot be broken. Dare we rest the fiscal health of our nation on such naive assumptions? As Stanford University economist John Cochrane makes clear, we shouldn’t.
Increased government borrowing to finance debt obligations doesn’t just crowd out other federal spending priorities; it also competes for funds in the nation’s capital markets, which in turn raises interest rates and crowds out private investment. Our own economic analysis demonstrates that such heightened levels of debt have a negative impact on economic growth potential, and in many cases that impact gets more pronounced as debt levels increase. While an aging population, low productivity growth and unconventional monetary policy have resulted in years of low interest rates, the empirical research finds that the growing public debt burden will put upward pressure on interest rates.
A 2019 CBO working paper found that the average long-term effect of debt on interest rates ranges from about 2 to 3 basis points for each percentage-point increase in debt as a percentage of GDP. With current public debt levels projected to potentially reach 269% of GDP by 2050, this could amount to upward pressure of 340 to 510 basis points on interest rates from current levels, or a rise in debt-bearing interest rates from 1.7% today to 5% or almost 7% in three decades. This will significantly outweigh any downward pressures exerted by other factors.
How then can we justify sending hundreds of billions of dollars in checks to wealthy families, extending overly generous ($400) unemployment benefits when businesses are trying to reopen, or bailing out fiscally irresponsible states, some of which have larger budgets than last year? And this on top of proposals for a multitrillion-dollar green infrastructure plan, student loan bailouts and free public college tuition, to mention just a few.
At the same time, the new chairman of the Senate Budget Committee, Sen. Bernie Sanders, is crafting reconciliation legislation to bypass Republican opposition to vast spending increases. This will allow a Democratic majority to throw more progressive policies into the mix (such as a $15 federal minimum wage) and massively inflate bailout funds for states that have profligately promised government workers pension and other retirement benefits they can’t afford.
This radical new idea that debt doesn’t matter must be challenged for the bad economic assumptions that underlie it. If we postpone consolidating our national debt, then swifter and deeper cuts to spending will have to be implemented, or alternatively, draconian tax hikes will have to be introduced that would make European tax rates look competitive by comparison. Since tax hikes have significant adverse effects on economic growth, most of the adjustment, if we are serious about avoiding fiscal crises, will have to come from spending reductions. Rather than debating sending checks to wealthy households, policymakers should instead be considering real institutional reform to change our debt trajectory.
As our debt-to-GDP (held by the public) ratio tops 100% and the clock runs down on Social Security and Medicare trust fund depletion, the next economic crises could be enough to push us into a serious debt crisis. The Biden administration needs to consider this reality before moving forward with huge new spending plans.