Tax Cuts Provide Better Stimulus Than Government Spending

It would have been impossible to predict in advance how the Missouri General Assembly finally decided to distribute the stimulus funding that the state received from the federal government. Although legislators ultimately decided to spend the stimulus to bolster various budget shortfalls, and on large-scale capital projects, the state House proposal to use a portion of the funds to provide Missourians with a tax cut deserved more consideration. Dismissing such an idea out of hand would ignore the tradeoffs present in any policy decision. Ideas need to be vetted instead of cast aside. In this way, we do justice to the legitimate discussions of economic policy.

Every dollar spent as part of the stimulus package is a dollar of debt that will have to be repaid by future taxpayers. (We accept here that the objective of the stimulus package is to increase economic activity.) Whether each dollar is well-spent or poorly spent does not change the fact that the spending creates additional debt. If the dollar is spent well by government officials, and promotes economic activity that stimulates our economy and encourages job growth, the value of the present spending may arguably outweigh the harm of the future debt. In such cases, government investment would yield returns in the form of greater future productivity. Transportation infrastructure is probably the best example of this — and, not surprisingly, is the least controversial part of the stimulus plan. In contrast, poorly spent dollars do not generate increases to economic activity, and so such a plan would fail to meet its primary goal: to stimulate the economy. It is more likely that, in such an instance, the present value of the dollar would be outweighed by the future burden of the debt.

At the state level, the American Recovery and Reinvestment Act provided federal monies that inside-the-box thinking maintained should be used by state governments to preserve state services. The mantra heard during Missouri’s debate was that the General Assembly needed to allocate the funds in order to educate kids, provide health care services, or otherwise choose the best use for all of us.

Reasonable people can disagree with the mantra. Such disagreement does not mean that these people are greedy folks who or are unwilling to pay their fair share of taxes. Rather, the premise underlying this reasoning — that government needs to decide what is in society’s best interest — is fatally flawed. We do not accept this premise.

Some legislators proposed creative plans with respect to the federal funds. However, the fundamental question should have been whether monies returned to Missourians would yield better outcomes than monies spent by the legislature, or whether the General Assembly knows better than the citizens how to spend the money.

What if the General Assembly had spent more money on K–12 education? Now, if these dollars translated into higher academic performance, this spending might be justified. However, research overwhelmingly shows that the marginal effect of an extra million dollars or so of educational funding does not result in improved performance. We would be left with an expenditure by the General Assembly that would yield no tangible return. Suppose instead that the legislators had returned the money to Missourians through a widespread tax cut. At minimum, these recipients would spend or save. Whatever they do, however, citizens would use the funds to make themselves as happy as possible, pursuing their own ends. Because legislators are not omniscient, we do not believe that the camp arguing “we have to spend federal monies” can begin to come close to obtaining such a result.

It is important to point out that it would be challenging to implement any plan to return the funds to Missourians, because they correspond with future tax liabilities. Unfortunately, there is no way of knowing the future tax burden of each Missourian. An ideal transfer would be proportionate to each recipient’s future tax liabilities, but absent an omniscient redistributor, the state could have simply chosen to return such funds to the federal government. If the funds were not allocated to Missouri by federal authorities in the first place, the result would come close to mimicking an omniscient redistributor, because Missouri’s portion of the future tax liability would ideally disappear.

However, the federal government has already committed to spend this money — if not in Missouri, then elsewhere. So, simply sending the funds back to Washington would leave Missourians worse off, because not only would they no longer have that money in their pockets, they would also see no reduction in their future tax liability. Even if the funds were distributed to Missouri taxpayers in a less than ideal fashion, a reasonable case could be made in favor of turning such funds over to Missourians rather than returning them to the federal government.

The legislative discussions of how to spend money that is not intended for a tax cut were a case study in logrolling politics. One late April proposal aimed to take stimulus money that had been originally planned for ethanol subsidies in rural areas and instead devote it to mass transit subsidies in urban areas. Determining which subsidy would have been better for Missouri is beside the point, because that move, and dozens of others like it, reveal that it is unreasonable — we might even say impossible — to expect that our legislators have the ability to know which public expenditure constitutes the best use for the money. Political power, influence, lobbying, and fighting for individual constituents will determine how the stimulus money gets spent — not some idealized dream of wise men having the ability to predict the future and put politics aside for the good of the state.

Joseph Haslag is executive vice president of the Show-Me Institute, a Missouri-based think tank, and a professor in economics at the University of Missouri–Columbia. David Stokes is a policy analyst at the Show-Me Institute.