2.11.2009

No Free Lunch


At work, I am often asked to project the economic and fiscal effect of some public intervention on the local economy, to model whether the public intervention is worth doing. So usually, the logic goes something like this: a) if we do nothing, then we get status quo levels of activity, vs. b) if we invest in something, like some public infrastructure or a subsidy for a proposed development, then we have to account for upfront public outlays but they result in higher levels of economic impact which then translate into higher tax revenues. Given reasonable assumptions, you should be able to determine whether the upfront investment is "worth it," in terms of it resulting in a positive return over time. (I put "worth it" in quotes because sometimes you have reasons for doing something even if it doesn't result in a positive monetary return over time, if there are compelling public benefits that can be had as a result of the investment.)

Clearly, a goal of the proposed stimulus bill is not only to provide short-term relief but to invest in things that will result in a more productive economy and thus translate into higher tax revenues over time. If the money is spent well, taking on additional debt is not a bad move: you get short-term relief, and when all is said and done, you get higher tax revenues over time which allow you to pay off the debt and still be ahead. To use an analogy at a personal level, this would be not unlike a young person going deeply into debt to fund higher education, betting on the likely prospect that the degree she earns will allow her to make a high enough salary that she is better off taking on debt and paying it off over time, than she is if she were to get a job and not go to college.

As linked to by Greg Mankiw's blog, models produced by Yale economist Ray Fair suggest that the stimulus package would indeed provide short-term relief, but it doesn't get us the long-term bump-up to avoid having to raise taxes in the future to pay off the debt we incur today. Sometimes, as with the college example above, there is such a thing as a free lunch: instead of carrying on with our current earning prospects, we take out debt, go to school, and emerge with a job whose salary is high enough above what we would've been able to get without the degree that we can pay off the student loans and be ahead financially over time. According to Fair's models, the stimulus package is not a free lunch: it may provide short-term relief, but it is insufficiently stimulative in the long-term to avoid having to raise taxes in the future to pay for it.
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