President Barack Obama is scheduled to place his signature Tuesday on the $787 billion economic stimulus bill. Unfortunately, the cost of debt and future taxes required to finance the stimulus largesse have largely been ignored to date.
Putting aside the issues of whether you support a stimulus, whether any stimulus would actually work, and whether this particular measure actually meets the test of a stimulus, there is still a core issue of its actual price tag. Ignoring the financing costs means that citizens and politicians alike are underestimating the costs of intervention.
The first and most obvious cost ignored so far is the interest that must be paid on the debt issued to finance the stimulus. Compound interest is wonderful for those on the receiving end (savers) but for those on the borrowing side, it can be a killer.
The Congressional Budget Office estimates the U.S. government will run deficits for the next 10 years without interruption before either the Troubled Asset Relief Program (TARP) or the stimulus are even considered. This means that not only will the amount of the stimulus bill have to be borrowed, but also the future interest payments. In other words, the price of the stimulus bill will compound until such time as the debt issued for it is paid off.
This increases the cost of the bill from $787 billion to $1.34 trillion over the next 10 years using current government interest rates. The amount increases to $1.5 trillion if interest rates increase by even a single percentage point. Given where interest rates are currently, they only have one way to go: up.
Borrowing money from the future to finance current stimulus thus increases the cost by more than 60 percent. But there is another important cost to consider: taxes.
Ultimately this borrowing will have to be repaid through future taxes. Given that we already owe ourselves $42.9 trillion in benefits for Social Security and Medicare that we don’t have the money for — according to the Peterson Foundation — coupled with the fact that the government is already facing trillion-dollar-plus annual deficits, the likelihood is that these future costs will be paid for by higher taxes rather than lower spending in other areas.
But taxes come at a price. By increasing existing taxes and/or by introducing new taxes, government will further distort economic behavior by making some things less expensive and others more expensive. This can have serious economic consequences when government makes productive activities like investment, entrepreneurship, and job creation more expensive compared to alternatives such as consumption.
There is considerable research on the cost of taxes with much of it focusing on the cost of raising one additional dollar of revenue (marginal effects). Harvard professor Dale Jorgensen completed an important study of such issues in 1991 and concluded that taxes impose costs and that different taxes impose different costs. For example, capital-based taxes impose a relatively high cost ($0.92 per $1 raised) while sales taxes impose relatively lower costs ($0.26 per $1 raised).
More recently, Harvard professor Martin Feldstein examined the cost of financing additional government spending by increasing marginal tax rates across the board. He concluded that additional government spending cost $1.76 per $1 spent. There may be differences regarding the magnitude, but there is no dispute that raising taxes imposes costs. These tax costs will further increase the real price tag of the stimulus bill.
These are difficult times and they understandably prompt politicians to act. However, making quick judgments without all the facts serves no one. The House and Senate versions of the stimulus both involve historical amounts of spending. We must understand the true price tag and the burden we’re asking the next generation of taxpayers to bear in terms of debt and interest payments.
Jason Clemens is the director of research and Adam Frey is a research fellow at the Pacific Research Institute (www.pacificresearch.org) in San Francisco, Calif.