Why the Obama Stimulus Law Failed

In February of 2009, President Obama signed the American Recovery and Reinvestment Act (ARRA) which totaled $789 billion in increased government spending. President Obama reassured anxious Americans that this spending would “revive our economy” and “create 3.5 million jobs” over the next two years. Christina Romer and Jared Bernstein, then President Obama’s chief economic advisors, put together an analysis which predicted that passage of the stimulus package would keep the unemployment rate under 8 percent, falling to 7 percent by the end of 2010. Since that time, the unemployment rate has remained above 9 percent for 20 consecutive months. There are 6.8 million fewer jobs than there were in 2009.  The stimulus bill failed. Why did it fail? It failed for two reasons: the theory was wrong and the execution was even worse.

The theory underlying the stimulus

Virtually all economists in all American universities are Keynesians.  Basic Keynesian theory concerning unemployment is this: unemployment is caused by a massive failure in demand – people stop spending their money.  Solution: take money from people who are not spending it, and give it to those more likely to spend it. The increased spending will put more people to work and end the unemployment problem. They teach that there is a multiplied effect of spending of government handouts. The multiplier is based on the Marginal Propensity to Save (MPS). In its most basic form spending should follow this chart:

Following this reasoning, the poor will spend most of their government handout. This spending will improve sales in stores. Stores will hire more employees. Manufacturers of products sold in stores will have more orders and so will hire more employees. These employees will spend more money.  Unemployment will be solved in a few months. Thus, an 800-billion-dollar increase in government spending could cause total output to rise by 1.6 trillion dollars (a multiplier of 1.5).  This was the basis for the White House projections of rapid recovery due to the stimulus bill.

The problem with this reasoning is this: Where did the $789 billion in increased government spending come from? It had to come from increased taxation (which did not happen) or from increased borrowing of money by the government (which is what did happen).  Businesses and consumers who spent their money on the $789 billion of government bonds did not spend or invest that money in the economy.  So the spending stream that puts people to work was deprived of $789 billion – thus cancelling the benefits of the stimulus.

Failure in execution

In the past, when a massive new spending program is proposed by the Federal Government, it is initially drafted by people in the Executive Branch and sent to the House of Representatives for enactment. Public hearings are held. The House and the Senate usually redraft the bill, adding many amendments, and pass an often much modified bill to the President for signature.  This process did not happen in January 2009.  Obama asked the Congress (not the Executive branch) to draft the legislation. In these hurried sessions (not more than four weeks was taken to write the biggest piece of legislation ever passed by the Federal Government) every pressure group lobby participated, getting many of their special spending ideas into the bill.

In his closing remarks on the stimulus bill House Appropriations Chairman David Obey called it “the largest change in domestic policy since the 1930s.” The 1,073-page bill was the biggest spending increase since World War II. But besides spending, the fine print expanded the role of the federal government across the breadth of American business, health care, energy and welfare policy. The roll call votes came less than 24 hours after House-Senate conferees had agreed to their deal. Democrats rushed the bill to the floor before Members could even read it much less have time to broadcast the details so the public could offer its verdict. It was not posted on the Internet, which could easily have been done.

What was in the bill?

In the first place, most of the spending did not begin until 2010 – a year later. Second, most of the spending required drafting implementing regulations and contracts which took a great deal of time. The largest amount of the stimulus was for tax cuts.  These, however, were not permanent. They were one time. The largest of about 40 different temporary tax cuts were these:

  1. “Making Work Pay” Tax Credit (Sec. 1001, Page 195). In tax years 2009 and 2010, the Making Work Pay provision will provide a refundable tax credit of 6.2 percent of earned income up to $400 for individuals and up to $800 for married taxpayers filing joint returns.
  2. Increase in the Earned Income Tax Credit (Sec. 1002, Page 198). Go to the stimulus bill for all the details, but it essentially expands this benefit for the working poor.
  3. Increased Eligibility for the Refundable Portion of Child Credit (Sec. 1003, Page 199). In 2009 and 2010, families who don’t earn enough to pay income tax would be eligible to claim the $1,000 child credit.
  4. “American Opportunity” Education Tax Credit (Sec. 1004, Page 199). Increases the Hope Scholarship Credit to $2,500.
  5. Refundable First-time Home Buyer Credit. (Sec. 1006, Page 202). This extended and increased the first-time home buyer tax credit from $7,500 to $8,000.

Do temporary tax benefits result in more spending? In general, no. Most people look ahead.  If people get a permanent tax cut, they feel free to spend some of it. If it is one time only, at a time of major unemployment, they are more likely to save it – which apparently is what most of them did.

So the stimulus bill did not involve much spending in 2009. What it did was boost the national debt by almost a trillion dollars.  The interest paid on this debt is already a big part of the federal budget. In 2010 we paid $413,954,825,362 on the total federal debt. The amount grows by a considerable amount every year.

About Arthur Middleton Hughes

Arthur is currently Vice President of The Database Marketing Institute based in Fort Lauderdale, FL. Arthur is the author of 11 books, the latest of which is Strategic Database Marketing 4th Edition (McGraw-Hill 2012). A BA graduate of Princeton with an MPA in Economics and Public Affairs, Arthur taught economics at he University of Maryland for 32 years. He is an Austrian Economist.
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