a throwback to the 1930s and 1970s, Democratic lawmakers are betting
that America's economic ills can be cured by an extraordinary expansion
of government. This tired approach has already failed repeatedly in the
past year, in which Congress and the President:
- Increased total federal spending by 11 percent to nearly $3 trillion;
- Enacted $333 billion in "emergency" spending;
- Enacted $105 billion in tax rebates; and
- Pushed the budget deficit to $455 billion in the name of "stimulus."
one of these policies failed to increase economic growth. Now, in
addition to passing a $700 billion financial sector rescue package,
lawmakers have decided to double down on these failed spending
policies by proposing a $300 billion economic stimulus bill. Even
though the last $455 billion in Keynesian deficit spending failed to
help the economy, lawmakers seem to have convinced themselves that the
next $300 billion will succeed.
This is not the first time
government expansions have failed to produce economic growth. Massive
spending hikes in the 1930s, 1960s, and 1970s all failed to increase
economic growth rates. Yet in the 1980s and 1990s—when the federal
government shrank by one-fifth as a percentage of gross domestic
product (GDP)—the U.S. economy enjoyed its greatest expansion to date.
comparisons yield the same result. The U.S. government spends
significantly less than the 15 pre-2004 European Union nations, and yet
enjoys 40 percent larger per capita GDP, 50 percent faster economic
growth rates, and a substantially lower unemployment rate.
conventional economic wisdom repeatedly fails, it becomes necessary to
revisit that conventional wisdom. Government spending fails to
stimulate economic growth because every dollar Congress "injects" into the economy must first be taxed or borrowed out of
the economy. Thus, government spending "stimulus" merely redistributes
existing income, doing nothing to increase productivity or employment,
and therefore nothing to create additional income. Even worse, many
federal expenditures weaken the private sector by directing resources
toward less productive uses and thus impede income growth.
The Myth of Spending as "Stimulus"
advocates claim that government can "inject" new money into the
economy, increasing demand and therefore production. This raises the
obvious question: Where does the government acquire the money it pumps
into the economy? Congress does not have a vault of money waiting to
be distributed: Therefore, every dollar Congress "injects" into the economy must first be taxed or borrowed out of the economy. No new spending power is created. It is merely redistributed from one group of people to another.
advocates typically respond that redistributing money from "savers" to
"spenders" will lead to additional spending. That assumes that savers
store their savings in their mattresses or elsewhere outside the
economy. In reality, nearly all Americans either invest their savings
by purchasing financial assets such as stocks and bonds (which finances
business investment), or by purchasing non-financial assets such as
real estate and collectibles, or they deposit it in banks (which
quickly lend it to others to spend). The money is used regardless of
whether people spend or save.
Government cannot create new
purchasing power out of thin air. If Congress funds new spending with
taxes, it is simply redistributing existing income. If Congress instead
borrows the money from domestic investors, those investors will have
that much less to invest or to spend in the private economy. If
Congress borrows the money from foreigners, the balance of payments
will adjust by equally reducing net exports, leaving GDP unchanged.
Every dollar Congress spends must first come from somewhere else.
does not mean that government spending has no economic impact at all.
Government spending often alters the consumption of total demand, such
as increasing consumption at the expense of investment.
More importantly, government spending can alter future
economic growth. Economic growth results from producing more goods and
services (not from redistributing existing income), and that requires
productivity growth and growth in the labor supply. A government's
impact on economic growth is, therefore, determined by its policies'
effect on labor productivity and labor supply.
growth requires increasing the amount of capital, either material or
human, relative to the amount of labor employed. Productivity growth is
facilitated by smoothly functioning markets indicating accurate price
signals to which buyers and sellers, firms and workers can respond in
flexible markets. Only in the rare instances where the private sector
fails to provide these inputs in adequate amounts is government
spending necessary. For instance, government spending on education, job
training, physical infrastructure, and research and development can
increase long-term productivity rates—but only if government spending
does not crowd out similar private spending, and only if government
spends the money more competently than businesses, nonprofit
organizations, and private citizens. More specifically, government
must secure a higher long-term return on its investment than
taxpayers' (or investors lending the government) requirements with the
same funds. Historically, governments have rarely outperformed the
private sector in generating productivity growth.
government spending improves economic growth rates on balance, it is
necessary to differentiate between immediate versus future effects.
There is no immediate stimulus from government spending, since that
money had to be removed from another part of the economy. However, a
productivity investment may aid future economic growth, once
it has been fully completed and is being used by the American
workforce. For example, spending on energy itself does not improve
economic growth, yet the eventual existence of a completed,
well-functioning energy system can. Those economic impacts can take
years, or even decades, to occur.
Most government spending has historically reduced productivity and long-term economic growth due to: 
Most government spending is financed by taxes, and high tax rates
reduce incentives to work, save, and invest—resulting in a less
motivated workforce as well as less business investment in new capital
and technology. Few government expenditures raise productivity enough
to offset the productivity lost due to taxes;
Social spending often reduces incentives for productivity by
subsidizing leisure and unemployment. Combined with taxes, it is clear
that taxing Peter to subsidize Paul reduces both of their incentives to
be productive, since productivity no longer determines one's income;
Every dollar spent by politicians means one dollar less to be allocated
based on market forces within the more productive private sector. For
example, rather than allowing the market to allocate investments,
politicians seize that money and earmark it for favored organizations
with little regard for improvements to economic efficiency; and
Government provision of housing, education, and postal operations are
often much less efficient than the private sector. Government also
distorts existing health care and education markets by promoting
third-party payers, resulting in over-consumption and insensitivity to
prices and outcomes. Another example of inefficiency is when
politicians earmark highway money for wasteful pork projects rather
than expanding highway capacity where it is most needed.
Mountains of academic studies show how government expansions reduce economic growth:
- Public Finance Review
reported that "higher total government expenditure, no matter how
financed, is associated with a lower growth rate of real per capita
gross state product."
- The Quarterly Journal of Economics
reported that "the ratio of real government consumption expenditure to
real GDP had a negative association with growth and investment," and
"growth is inversely related to the share of government consumption in
GDP, but insignificantly related to the share of public investment."
- A Journal of Macroeconomics
study discovered that "the coefficient of the additive terms of the
government-size variable indicates that a 1% increase in government
size decreases the rate of economic growth by 0.143%."
- Public Choice
reported that "a one percent increase in government spending as a
percent of GDP (from, say, 30 to 31%) would raise the unemployment
rate by approximately .36 of one percent (from, say, 8 to 8.36
growth is driven by individuals and entrepreneurs operating in free
markets, not by Washington spending and regulations. The outdated idea
that transferring spending power from the private sector to Washington
will expand the economy has been thoroughly discredited, yet lawmakers
continue to return to this strategy. The U.S. economy has soared
highest when the federal government was shrinking, and it has stagnated
at times of government expansion. This experience has been paralleled
in Europe, where government expansions have been followed by economic
decline. A strong private sector provides the nation with strong
economic growth and benefits for all Americans.
Three Applications of the Spending Fallacy
myth of government spending stimulus is often found in debates over tax
rebates (which function similar to government spending), highway
spending, and federal bailouts of states.
1) Why Tax Rebates Do Not Stimulate
debate on taxes and economic growth is also clouded with confusion. By
asserting that tax cuts spur economic growth by "putting spending money
in people's pockets," many tax cutters commit the same fallacy as do
government spenders. Similar to government spending, the money for tax
cuts does not fall from the sky. It comes out of investment and net
exports if financed by budget deficits or government spending if
offset by spending cuts.
However, the right tax cuts can add
substantially to productivity. As stated above, economic growth
requires that businesses produce increasing amounts of goods and
services, and that requires consistent business investment and a
growing, productive workforce. Yet high marginal tax rates— defined as
the tax on the next dollar earned—create a disincentive to engage in
those activities. Reducing marginal tax rates on businesses and
workers will increase incentives to work, save, and invest. These
incentives encourage more business investment, a more productive
workforce by raising the after-tax returns to education, and more work
effort, all of which add to the economy's long-term capacity for
Thus, not all tax cuts are created equal. The economic
impact of a tax cut is measured by the extent to which it alters
behavior to encourage productivity.
Tax rebates fail to increase
economic growth because they are not associated with productivity or
work effort. No new income is created because no one is required work,
save, or invest more to receive a rebate. In that sense, rebates are
economically indistinguishable from government spending programs that
write each American a check. In fact, the federal government treats
rebate checks as a "social benefit payment to persons." They represent another feeble attempt to create new purchasing power out of thin air.
the 2001 tax rebates. Washington borrowed billions from the capital
markets, and then mailed it to Americans in the form of $600 checks.
Rather than encourage income creation, Congress merely transferred
existing income from investors to consumers. Predictably, the following
quarter saw consumer spending surge from 1.4 percent to 7.0 percent,
and gross private domestic investment spending drop correspondingly by
22.7 percent The overall economy grew at a meager 1.6 percent that quarter, and remained stagnant through 2001 and much of 2002.
was not until the 2003 tax cuts—which cut tax rates for workers and
investors— that the economy finally and immediately began a robust
recovery. In the previous 18 months, business investment had
plummeted, the stock market had dropped 18 percent, and the economy had
lost 616,000 jobs. In the 18 months following the 2003 tax rate
reductions, business investment surged, the stock market leaped 32
percent, and Americans created 307,000 new jobs (followed by 5 million
jobs in the next seven quarters). Overall economic growth rates doubled.
tax rates were reduced throughout the 1920s, 1960s, and 1980s. In all
three decades, investment increased, and higher economic growth
followed. Real GDP increased by 59 percent from 1921 to 1929, by 42
percent from 1961 to 1968, and by 31 percent from 1982 to 1989.
in a triumph of hope over experience, lawmakers embraced tax rebates
over rate reductions again in early 2008. While the economic data are
still coming in, it is clear that once again the rebates failed to
support economic growth. There is no reason to expect another round of
tax rebates to be any more effective.
2) Highway Spending: The Myth of the 47,576 New Jobs
is the government spending stimulus myth more widespread than in
highway spending. Congress is already rumbling to push billions in
highway spending in the next stimulus package. Over the years,
lawmakers have repeatedly supported their errant claim that highway
spending is an immediate economic tonic by citing a Department of
Transportation (DOT) study. This study supposedly states that every $1
billion spent on highways adds 47,576 new jobs to the economy.
The problem: The DOT study made no such claim. It stated that spending $1 billion on highways would require
47,576 workers (or more precisely, it would require 26,524 workers,
who then spend their income elsewhere, supporting an additional 21,052
workers). But before the government can spend $1 billion hiring road
builders and purchasing asphalt, it must first tax or borrow $1
billion from other sectors of the economy—which would then lose a
similar number of jobs. In other words, highway spending merely
transfers jobs and income from one part of the economy to another. As
The Heritage Foundation's Ronald Utt has explained, "The only way that
$1 billion of new highway spending can create 47,576 new jobs is if the
$1 billion appears out of nowhere as if it were manna from heaven."
The DOT report implicitly acknowledged this point by referring to the
transportation jobs as "employment benefits" within the transportation
sector, rather than as new jobs for the total economy.
April 2008 DOT update to its previous study reduced the employment
figure to 34,779 jobs supported by each $1 billion spent on highways,
and explicitly stated that the figure "refers to jobs supported by highway investments, not jobs created." Similarly, a Congressional Research Service study calculated similar numbers as the DOT study, but cautioned:
the extent that financing new highways by reducing expenditures on
other programs or by deficit finance and its impact on private
consumption and investment, the net impact on the economy of highway
construction in terms of both output and employment could be nullified
or even negative.
surprisingly, highway spending has a poor track record of stimulating
the economy. The Emergency Jobs Appropriations Act of 1983
appropriated billions of dollars in highway spending (among other
programs) in hopes of pushing the double-digit unemployment rate
downward. Years later, an audit by the General Accounting Office (GAO,
now the Government Accountability Office) found that highway spending
generally failed to create a significant number of new jobs.
The bottom line is that there is no reason to expect additional highway
spending this year to boost short-term economic growth or create new
As stated above, resulting improvements in the nation's infrastructure may increase future productivity and growth—once they are completed and in use. This is not
the same as suggesting that the act of spending money on additional
highway workers and asphalt is itself an immediate stimulant. Even the
hope of future productivity increases rest on the assumptions that
politicians will allocate money to necessary highway projects (rather
then pork), and that those future productivity benefits will outweigh
the lost productivity from raising future tax rates to finance the
3) State Bailouts Merely Shift Money Around
is reportedly considering using stimulus funding to bail out states
dealing with their own budget shortfalls. This makes little sense as a
matter of macroeconomic policy. State spending does not suddenly become
stimulative because it is funded by Washington instead of state
governments. Either way, any spending "injected" into the economy must
first be taxed or borrowed from the economy. It does not matter which
level of government is doing the taxing, borrowing, or spending.
sending federal aid to states would not save taxpayers a dime because
state taxpayers are also federal taxpayers. Increasing federal
borrowing to keep state taxes from rising is like running up a Visa
card balance to keep the Mastercard balance from rising. The overall
costs do not change, only the address receiving the payment.
typically respond that a federal bailout is preferable because it
could be funded with deficits rather than new taxes—currently not an
option for the 49 states with balanced-budget requirements. But nobody
forced these states to enact balanced-budget requirements, which they
are free to repeal. It is disingenuous for a state to enact a
balanced-budget amendment, and then demand that Washington bail it out
of the consequences of its own policy.
Congress already sends $467 billion to state and local government every year—up 29 percent after inflation since 2000.
This is well beyond what is needed to reimburse states for federal
mandates. In fact, since 1996, Washington has imposed less than $25
million per state in new unfunded mandates. (No Child Left Behind is
neither unfunded nor mandated.) State health, education, and transportation programs remain heavily subsidized by Washington.
states are so dependent on income tax revenues—which are
volatile—common sense says to build rainy-day funds during booms to
cushion the inevitable recessions. Instead, states keep responding to temporary revenue surges with new permanent
spending programs. Between 1994 and 2001, states flush with new
revenues shunned rainy-day funds and instead expanded their general
fund budgets by 6.2 percent annually.
booms eventually end, and these free-spending states left themselves
utterly unprepared for the 2002–2003 economic slowdown. Yet instead of
sufficiently paring back their bloated budgets, the states demanded
and received a $30 billion bailout from Washington in 2003. When
government bails out irresponsible behavior, it only encourages more
irresponsibility. And that is just what happened: After the 2003
bailout, states went right back to spending—with annual budget hikes
averaging 7.2 percent over the next four years.
Rainy-day funds were expanded, although not nearly by enough. Thus,
another recession has brought another round of state bailout calls.
How will states learn to budget responsibly if they know they can keep returning to the federal ATM?
biggest losers from a federal bailout are the taxpayers who live in
fiscally responsible states. They played by the rules and resisted
extravagant new spending programs—and will be "rewarded" with higher
taxes to bail out neighboring states that went on a spending spree they
could not afford.That is simply unfair. And it encourages responsible
states to be less responsible next time—better to be the bailout
recipient than the bailout payer.
Congress should resist a
bailout and instead instruct state governments to set priorities, make
trade-offs, and reduce unnecessary spending. States that insist on
deficit spending should reform their own balanced-budget laws rather
than demand that Washington borrow for them. Finally, any federal aid
to state governments should come in the form of loans to be repaid in
full, with interest, within three years.
A Better Way
spending has an abysmal track record of stimulating the economy.
However, these repeated failures have not stopped lawmakers from
proposing and enacting a seemingly endless string of "stimulus" bills.
Rather than redistributing money, lawmakers should focus on improving
long-term productivity. This means reducing marginal tax rates to
encourage working, saving, and investing. It also means promoting free
trade, cutting unnecessary red tape, and streamlining wasteful spending
that all weaken the private sector's ability to generate income and
create wealth. Finally, it means strengthening education—not just
throwing money at it. Addressing long-term growth and productivity is
more challenging than waving the magic wand of short-term "stimulus"
spending—but a more productive economy will be better prepared to
handle future economic downturns.
 This originally appeared in Daniel J. Mitchell, "The Impact of Government Spending on Economic Growth," Heritage Foundation Backgrounder No. 1831, March 15, 2005, at http://www.heritage.org/research/budget/bg1831.cfm.
The EU–15 consists of the 15 member states of the European Union before
the 2004 enlargement: Austria, Belgium, Denmark, Finland, France,
Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands, Portugal,
Spain, Sweden, and the United Kingdom.
 The Federal Reserve could fund new spending by printing new money, which would only create inflation.
 This list was influenced by Daniel J. Mitchell, "The Impact of Government Spending on Economic Growth."
 S. M. Miller and F. S. Russek, "Fiscal Structures and Economic Growth at the State and Local Level," Public Finance Review, Vol. 25, No. 2 (March 1997).
 Robert J. Barro, "Economic Growth in a Cross Section of Countries," Quarterly Journal of Economics, Vol. 106, No. 2 (May 1991), p. 407.
 James S. Guseh, "Government Size and Economic Growth in Developing Countries: A Political-Economy Framework," Journal of Macroeconomics, Vol. 19, No. 1 (Winter 1997), pp. 175–192.
 Burton Abrams, "The Effect of Government Size on the Unemployment Rate," Public Choice, Vol. 99 (June 1999), pp. 3–4.
 These growth rates are annualized. See U.S. Commerce Department, Bureau of Economic Analysis, NIPA Tables, Table 1.1.1, at http://www.bea.gov/bea/dn/nipaweb/SelectTable.asp
(November 7, 2008). Consumption and investment spending changed by
similar dollar amounts, but because investment spending begins at a
lower base figure, its percentage change is larger.
 U.S. Commerce Department, Bureau of Economic Analysis, NIPA Tables, Table 1.1.1; Yahoo Finance, "S&P 500 Index," at http://www.finance.yahoo.com/q/hp?s=%5EGSPC
(November 7, 2008); and U.S. Department of Labor, Bureau of Labor
Statistics, "Employment, Hours, and Earnings from the Current
Employment Statistics Survey (National)."
pro-growth tax cuts are not designed simply to "put money in people's
pockets," their proponents do not focus on whether recipients are rich
or poor. Tax relief policies should be designed to maximize long-run
economic growth, which in turn raises incomes across the board. Thus,
raising marginal tax rates on "the wealthy" to finance tax rebates from
low-income families may satisfy a redistributive agenda, but it would
also reduce economic growth and eventually lower incomes across the
board. It is better for everyone to reduce tax rates across the board
and encourage all Americans to work, save, and invest.
Impacts of Highway Infrastructure Investment," Department of
Transportation, Federal Highway Administration, April 7, 2008.
(Emphasis in original.) Report no longer appears on DOT Web site.
Contact author for original PDF file.
 David J. Cantor, "Highway Construction: Its Impact on the Economy," Congressional Research Service Report for Congress No. 93–21E, January 6, 1993.
the project could be financed by borrowing. However, long-term economic
growth requires that the government obtain a higher return on its
investment than the private sector would have with those funds.