Stimulus Multiplier Magic

It's been a long time since Americans have seen what happens when the federal government spends big money specifically to rejuvenate an economy on life support.

70 years, in fact. So if you're too young to remember why Depression families ended the 1930s worshipping the ground FDR walked on, Ann Pettifor provides a quick refresher on how it works.

The fiscal stimulus will pay for itself. Here's how.

At times of high unemployment tax cuts may be saved and not spent into the economy. But when the government invests the bulk of $789 billion in real, productive economic activity - it always gets its money back - plus some.

It works like this. Government invests in labor-intensive programs e.g. $40 billion in energy efficiency and renewable energy programs, including $2.9 billion to weatherize modest-income homes. $27 billion for highway and bridge construction and repair and $11.5 billion for mass transit and rail projects; $4.6 billion for the Army Corps of Engineers; $5 billion for public housing improvements; $6.4 billion for clean and drinking water projects.

The energy efficiency/transportation/public housing programs hire American workers - some highly skilled, some not so skilled. These programs also purchase materials - from factories. Some foreign, but mostly American.

Next, something called 'the multiplier' kicks in. It's the ABC of economic science and works like this.

The workers get pay checks. They use the income to pay taxes - direct to the US government. So immediately the government can use these tax revenues to fix the budget. Then workers purchase goods and services - boosting the economy. Companies hire more workers to deal with demand for materials from stimulus-sponsored programs. More employed workers equals more taxpayers.

Ever-rising tax revenues drop into the Treasury's coffers.

Because government spending is financed by bank money or credit, income increases. Eventually savings are generated to match the original stimulus expenditure - so there is no 'crowding out' by government. But savings too can find a way back to the US Treasury, because savers could end up investing in US Treasury bonds.

If workers or factories spend money on goods made in China - then some will leak out to China. But experience shows that investment in public works tends to be local investment. By weatherizing the homes of the poor, strengthening flood defenses, growing forests to act as pollution 'sinks' and subsidizing organic farming - investment stays at home.

But investing in this kind of economic activity is not the only revenue source for the US government.

A massive improvement to the budget will be in savings made in unemployment payments.

I looked up the Congressional Budget Office's estimates for expenditure on unemployment compensation and food stamps for the years 2009 - 2015. Their estimates are optimistic. The Congressional Budget Office thinks unemployment is going to decline after 2009. Nevertheless, even under its conservative estimates expenditures on unemployment compensation and food stamps rise to a massive $818 billion between now and 2015.

If the numbers of unemployed people were cut, and if Americans had enough income not to rely on food stamps - Congress would make massive savings to the budget. If we add those savings to the tax revenue generated thanks to the 'multiplier effect' - the outlook is positively rosy for a surplus on the budget as the economy recovers.

So lets not have any more talk of the 'crippling effects' of the American Recovery and Reinvestment Act of 2009.

Click here for President Obama's prepared remarks for the stimulus bill signing this afternoon.

Cross-posted at They Gave Us A Republic.