INSIGHTS: STRENGTHENING AUTOMATIC STABILIZERS
Guest Columnists: Timothy Taylor, Managing Editor of the Journal of Economic Perspectives, Author of Principles of Economics and the Economy, and purveyor of the Conversable Economist blog. Reprinted with permission.
For economists, “automatic stabilizers” refers to how tax and spending policies adjust without any additional legislative policy or change during economic upturns and downturns–and do so in a way that tends to stabilize the economy. For example, in an economic downturn, a standard macroeconomic prescription is to stimulate the economy with lower taxes and higher spending. But in an economic downturn, taxes fall to some extent automatically, as a result of lower incomes. Government spending rises to some extent automatically, as a result of more people becoming eligible for unemployment insurance, Medicaid, food stamps, and so on. Thus, even before the government undertakes additional discretionary stimulus legislation, the automatic stabilizers are kicking in.
Might it be possible to redesign the automatic stabilizers of tax and spending policy in advance so that they would offer a quicker and stronger counterbalance when (not if) the next recession comes? The question is especially important because in past recessions, the Federal Reserve often cut the policy interest rate (the “federal funds” interest rate) by about five percentage points. But interest rates are lower around the world for a variety of reasons, and the federal funds interest rate is now at 2.5%. So when the next recession comes, monetary policy will be limited in how much it can reduce interest rates before those rates hit zero percent, and will instead need to rely on nontraditional monetary policy tools like quantitative easing, forward guidance, and perhaps even experiments with a negative policy interest rate.
Heather Boushey, Ryan Nunn, and Jay Shambaugh have edited a collection of eight essays under the title Recession Ready: Fiscal Policies to Stabilize the American Economy (May 2019, Hamilton Project at the Brookings Institution and Washington Center for Equitable Growth).
In one of the essays, Louise Sheiner and Michael Ng look at US experience with fiscal policy during recessions in recent decades, and find that it has consistently had the effect of counterbalancing economic fluctuations. They write: “Fiscal policy has been strongly countercyclical over the past four decades, with the degree of cyclicality somewhat stronger in the past 20 years than the previous 20. Automatic stabilizers, mostly through the tax system and unemployment insurance, provide roughly half the stabilization, with discretionary fiscal policy in the form of enacted tax cuts and increased spending accounting for the other half.”
Automatic stabilizers are important in part because the adjustments can happen fairly quickly. In contrast, when the discretionary Obama stimulus package–American Recovery and Reinvestment Act of 2009–was signed into law in February 2019, the Great Recession had started 14 months earlier.
In another essay, Claudia Sahm proposes that along with the already-existing built-in shifts in taxes and spending, fiscal stabilizers could be designed to kick in automatically when a recession starts. In particular, she proposes that the trigger for such actions could be when “the three-month moving average of the national unemployment rate has exceeded its minimum during the preceding 12 months by at least 0.5 percentage points. … The Sahm rule calls each of the last five recessions within 4 to 5 months of its actual start. … The Sahm rule would not have generated any incorrect signals in the last 50 years.”
Sahm argues that when this trigger is hit, the federal government should have legislation in place that would immediately make a direct payment–which could be repeated a year later if the recession persists. She makes the case for a total payment of about 0.7% of GDP (given current GDP of around $20 trillion, this would be $140 billion). She writes: “All adults would receive the same base payment, and in addition, parents of minor dependents would receive one half the base payment
per dependent.” This isn’t cheap! But a lasting and persistent recession is considerably more expensive.
Other chapters of the book focus on a number of other proposals, which include:
-“[T]ransfer federal funds to state governments during periods of economic weakness by automatically increasing the federal share of expenditures under Medicaid and the Children’s Health Insurance Program”
-“[C]reating a transportation infrastructure spending plan that would be automatically triggered during a recession”
-Publicize availability of unemployment benefits when the unemployment rate starts rising, and extend the length of unemployment insurance payments at this time
-Expand Temporary Assistance for Needy Families to include subsidized jobs in recessions
-An automatic rise of 15% in Supplemental Nutrition Assistance Program (SNAP) benefits during recessions
-The list isn’t exhaustive, of course. For example, one policy used during the Great Recession was to have a temporary cut in the payroll taxes that workers pay to support Social Security and Medicare. For most workers, these taxes are larger than their income taxes. And there is a quick and easy way to get this money to people, just by reducing what is withheld from paychecks.
-The broader issues here, of course, is not about the details of specific actions, some of which are more attractive to me than others. It’s whether we seize the opportunity now to reduce the sting of the next recession.
For estimates of automatic stabilizers in the past, see “The Size of Automatic Stabilizers in the US Budget” (November 23, 2015).
ON THE ECONOMY: MODERN LOVE
John Dunham, Managing Partner, John Dunham & Associates
It’s time to buy back the block, buy back the block. It’s time to buy back the block, buy back the block. It’s time to buy back the hood, buy back the hood. It’s time to buy back the hood, buy back the hood. It’s time to buy back the hood, buy back the hood. So go the rather inspired lyrics to the 2016 song Buy Back the Block, by Florida based rapper Rick Ross and featuring 2 Chainz and Gucci Mane. The rappers were discussing how they could use their ill-gotten gains to purchase all of the legitimate businesses in their neighborhood.
This song actually mirrors in some way the nature of corporate stock buybacks and dividends, two tools that public companies use to transfer earnings to their shareholders. Following the 2007 recession, corporate stock buybacks and dividends have been the predominant use of public companies’ earnings, and have reached (according to Yardeni Research) about 100 percent over the past three years. In other words, public companies are sending all of the cash they are making – on net – to shareholders. This is one reason why market prices have been rising. Even with the recent downturn, the S&P 500 is up by 46.8 percent since 2016.
A misunderstanding of what dividends and buybacks represent has led many in Congress on both sides of the aisle to try to pass legislation limiting them. The argument is that rather than investing or paying their workers, companies are simply transferring wealth to rich oligarchs.
One thing is certain, by reducing the number of shares on the market, companies that buyback stock have greatly increased the price-earnings ratio of the market. In fact, even accounting for fluctuations, the P-E ratio of the S&P 500 has risen threefold, from about 8 or 9 to 27. As intended, buybacks have increased capital gains. But is this a bad thing for the economy?
It is important to understand what a corporation is supposed to do with its profits. First and foremost, a corporation should retain sufficient earnings to help ensure its smooth operation. Accountants call this working capital. Second, corporations should use their expertise and scale to find ways to successfully grow future profits. It is generally more efficient and profitable for an incumbent company in a market to expand than it is for a new company to enter the market. That is why Ford, for example, is more profitable than Tesla.
But sometimes a market is shrinking, or there are simply no good investments to be made. Take for example the market for cigarettes. This is a market that is declining rapidly and where there is substantial overcapacity. It would simply make no sense for a tobacco manufacturer to invest in increased cigarette production. In a case like this corporations have four choices. First, they can attempt to enter new markets. They can also spend more money on art work, or airplanes or even salaries, benefitting employees and management. They could also lower prices and thereby transfer more of their profits to consumers, and finally they can give more profits to shareholders – either through dividends and buybacks. To put it simply, capital generated by a corporation can go toward investment, labor, consumers or shareholders.
There are economic benefits and drawbacks to each of these. History has shown that most conglomerates have underperformed. There are generally diseconomies in trying to operate dozens of different businesses at the same time. General Electric is a recent example of how corporate empire building has led to decline. In addition, companies tend to overpay for acquisitions, particularly when they are outside of management’s area of expertise. As such, entering new markets tends to neither benefit companies or the economy.
Companies could spend more on workers, but in effect, spending more on workers translates into spending more on senior management. Two great examples of this were Tyco and Worldcom, where executives threw lavish parties, bought expensive artworks, and traveled the world in their corporate jets. Profits rarely trickle down to employees because the market for labor determines salaries for secretaries, accountants, janitors and assembly workers.
Companies that shift profits to consumers are in effect dumping product on the market, something that is often illegal. In many cases there are minimum pricing and markup laws that companies need to abide by, and in other cases they would be taken to court. Undercutting prices will also eliminate competition causing even more economic hardships. All of the empty storefronts on city high streets and in malls shows the effect of predative pricing. Amazon puts other retailers out of business by losing money on every sale. Uber harms taxi drivers by losing money on every ride. This would be the case if companies simply transferred profits to consumers.
Finally, companies can do what they were actually set up to do – make money for their investors. They do this by transferring profits to shareholders either through dividend payments or stock repurchases. More and more companies have tended toward buybacks simply because there are tax advantages to shareholders – something set up by the tax code not nefarious executives. When companies do not have good places to invest their earnings, they actually help the economy by sending money back to shareholders, allowing them to find other companies to invest in, thereby growing the economy and creating new products, services and eventually profitable firms. There would be no Netflix, no Apple, no Starbucks if investors did not have capital available to them to fund these companies when they were nothing more than ideas. By transferring profits to shareholders, companies help to increase productivity and grow the economy.
The bottom line is that corporate directors are actually doing the best thing for the economy, for their customers, for their industries and for their workers by buying back shares. Current tax laws, regulatory burdens and labor market conditions simply ensure that It’s time to buy back the block.