Federal Fiscal Stimulus for South Carolina

Let’s talk about Fiscal Stimulus, especially as it relates to South Carolina. As you have probably heard, South Carolina’s Governor Sanford is on the fence about accepting the Federal money offered to his state. Some of the Governor’s reasoning is that he doesn’t want to increase the National Debt and force his citizens to pay more taxes. Dose this reasoning make sense unless all of the Governor of all fifty states refuse the money? Read Doctor Woolsey’s article to see his logic is and whether or not he recommends that Governor Sanford accepts the fiscal stimulus package.

By Bill Woolsey, Special Economic Correspondent of The Free Enterprise Foundation

The Federal Government’s $787 billion fiscal stimulus program includes funds to help state governments avoid spending cuts. About $700 million of those funds are allocated to South Carolina. Governor Sanford was willing to use those funds to pay down state debt, but favors cutting spending rather than using Federal money for current state operations. South Carolina’s share is tiny compared to the total federal stimulus, about one-tenth of a percent, but it is about 4% of total state spending and about 12% of general fund revenue. Should Governor Sanford accept the funds?

The Obama administration’s deficit spending program, when added to those of the Bush administration, will impose a heavy tax burden upon all of our children and grandchildren. According to President Obama, the fiscal stimulus is essential for the health of the U.S. economy. However, fiscal stimulus is unnecessary and potentially counterproductive.

The speculative bubble in housing prices and the excess capacity in producing single family homes that developed over the last decade require a shift of labor to the production of other goods and services. Unfortunately, such shifts are slow and painful. During the adjustment period, reduced production and employment requires sacrifice. It is reasonable to expect reduced levels of state government services.Further, instituting a surge in new federal government programs does not help reallocate resources. While the new programs will utilize labor and other resources, it will still take time to allocate resources to government programs. And once temporary programs are finished, the resources still must be reabsorbed into the private sector. Instead of shifting resources once, a temporary fiscal stimulus involves shifting resources twice

Unfortunately, a new set of problems were added in the second half of last year. Consumption and nonresidential investment spending fell rapidly. While the fiscal stimulus plan does little to help reallocate resources, it can fill the gap in total spending. A better approach would be for the Federal Reserve to increase the quantity of money (and stop paying interest on banks’ reserve balances.) If the Fed used quantitative easing to return total spending to the growth path of last year, then spending on private consumption and nonresidential investment would recover and, over time, be sufficient to utilize the resources that had been producing single family housing. This would require no increase in the national debt and all the resources would be reabsorbed into the private sector the first time, without passing through a period of government employment. Sanford’s opposition to the Obama administration’s debt-financed spending is fully justified.

Unfortunately, the Obama administration didn’t listen and the national debt is going to expand. If a fiscal stimulus plan was inevitable, the best approach would have been an investment tax credit. That would help reverse the reduction in investment, and generate additional output and income to pay taxes on the interest expense of the added national debt. The tax cuts actually in Obama’s plan, more oriented to households, at least help reverse the drop in consumption spending, To the degree they are saved, households will be better able to pay interest on the added national debt. While tax cuts that are saved don’t do much to expand total spending, the Federal Reserve can generate any needed spending.

However, the third best option is using federal government money to dampen decreases in state government spending. The failure of the Fed to maintain spending resulted in lower income and less consumption spending, which reduced revenue from the state income and sales taxes. When state governments respond by cutting their spending, that exacerbates the problem. If the federal government provides money to the states to help cushion those cuts, the secondary drop in spending is less severe. There is no need to reallocate resources to new government programs, because existing programs are being maintained. Will state spending still need to be cut when the federal monies are gone? No, because the economy will recover and state income tax and sales tax revenues will recover as well.

The nearly billion dollar “mid year” reductions in spending ordered during 2007 and 2008 have simply lowered adjusted spending to a sustainable level. After the spending cuts, the roughly $6 billion in spending in 2008 was very close to the long term trend of revenues. However, revenue is now below trend-- $200 million short in 2008 with forecasts of shortfalls of $400 million in 2009 and $200 million in 2010.

I believe that Governor Sanford should accept the $700 million in federal funds to maintain spending at the sustainable long run trend. Dampening drops in state government spending is one of the least bad forms of fiscal stimulus. And, sadly, the national debt is going to increase and our children and grandchildren will not be given a break on their federal taxes. After the economy recovers, there will be time to continue to reduce taxes rates and government spending in South Carolina. And more importantly, to face the real challenge of rolling back the massive increases in federal government spending instituted by the Obama administration.

Copyright © 2009 by William Woolsey and The Free Enterprise Foundation. All rights reserved

About the author: Professor William Woolsey is a member of The Free Enterprise Foundation's editorial staff and senior writer on national economy reporting. Dr. Woolsey is a distinguished Professor of Economics in the Citadel’s School of Business Administration and a former Libertarian candidate for Congress.

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