Congress and the President have power over taxation and government spending. To understand the influence that they can have on increasing GDP in a recession, we need only to look again at our definition:
If any of the components of GDP increase, then by the definition, GDP will
increase. When we are in a recession, the government can increase GDP by
several actions involving taxation and spending:
Taxation
- Congress and the President can decrease the rate of income taxes, thereby giving consumers more disposable income. Since consumers on average spend 95% of their disposable income, they will spend most of it on goods and services, thereby increasing GDP. This creates increased consumption, but it is a much slower way to get money into consumer hands compared to a stimulus check.
- Congress can give consumers a tax rebate; that is, they give a tax refund to everyone or to a large number of people. For example, during the Pandemic Recession, Congress sent a tax rebate of $1,200 to everyone who made less than $75,000. Again, the expectation is that consumers will spend most of the rebate. This gets money into consumer hands quickly. However, during the Bush era, most people used their $1800 stimulus check to pay down credit card bills. This does not stimulate the economy.
- Congress can increase unemployment compensation by increasing the amount paid or lengthening the time that laid-off workers can collect unemployment. Regular unemployment compensation only lasts 26 weeks, and since it is administered by the states, the weekly amount paid varies widely from $235 per week in Mississippi to $649 per week in Connecticut. During the Great Recession, Congress extended unemployment compensation to 99 weeks and funded it with federal money. They also authorized a massive increase in the Food Stamp Program (called SNAP) which was often used by the SNAP administrators to replace unemployment compensation after a worker used up their 99 weeks of unemployment payments. In the CARES Act, Congress added a $600 per week payment to everyone collecting unemployment compensation that expired on July 31, 2020. The CARES Act also added unemployment benefits to the self-employed and gig workers, who are not eligible for state unemployment compensation. This gets money to the unemployed so they do not get desperate. It also helps maintain consumption to previous levels. However, many conservatives believe that the total unemployment compensation for a lot of individuals is more than they earned when working, so it creates a disincentive to going back to work. That might make it difficult to open up the economy again.
- Congress can enact a payroll tax cut for individuals. Individual workers have deducted 6.25% of their pay for Social Security insurance and 1.5% of their pay for Medicare/Medicaid Insurance. These are called payroll taxes as opposed to income taxes. President Obama reduced payroll taxes for individuals during the Great Recession in order to give more disposable income to consumers. President Trump advocated for a payroll tax cut, but it was rejected by both Republicans and Democrats. This puts more money in consumers’ hands which hopefully they will spend. However, it is not as quick as a $1200 tax rebate check, and critics say that a payroll tax cut helps the employed but not the unemployed (of whom there were 20 million).
- Congress can authorize expansion of other transfer payments such as food stamps and welfare payments to help struggling people who are out of work. This gets money to struggling people.
Spending
- Congress can allocate extra money for construction projects, such as roads and bridges. This increases employment almost immediately and brings more money into the economy, particularly into the hands of construction workers, whose wages are about 55% of construction projects. For example, $105 billion of the $787 billion stimulus package that the Obama administration passed in 2009 was allocated to “shovel ready” construction projects by state and local governments, including roads, bridges, rail projects, and internet infrastructure. Government spending increases the GDP on a dollar-for-dollar basis, unlike sending stimulus checks to households (who spend 95% and save 5%). It also creates a multiplier effect, as the construction workers spend their wages from the jobs. However, a lot of economists say this program was not successful for two reasons: several of the “shovel ready” projects had long delays and, as economist Robert Hall of Stanford noted, governments that had “shovel ready” projects had already arranged funding for them so the stimulus did not increase the number of projects significantly; it merely replaced the financing for existing projects.
- Congress can authorize aid to state and local governments. The G in the GDP equation includes all spending by federal, state, and local governments, so increased spending by states or local municipalities will increase G which then increases GDP. States and local government revenue can decline dramatically during lengthy or deep recessions, threatening layoffs of police, firefighters, and teachers. Sending aid to states and local municipalities can at the least avoid these layoffs and, depending on the amount authorized, help stimulate the economy. For example, the Obama era stimulus package had $144 billion allocated to state and local aid. The Congressional Budget Office estimated this aid either saved or created approximately three million jobs. This local aid saves and creates jobs. However, it can be difficult to wean the state and local governments off the federal aid.
- The Federal Government can just hire people. The IRS has faced massive budget cuts over the last twenty years. President Trump has ordered large budget cuts at the State Department. There are likely dozens of federal agencies that could use more help. This creates jobs, which is what government stimulus is all about. For conservatives, though, this is seen as expanding the role of “Big Government.”
- The Federal Government can go to war. I dislike bringing up this federal policy alternative, but for the longest time, the perceived wisdom was that war is good for the economy. It sent men and women overseas, thereby decreasing unemployment, and it involved huge government expenditures on arms and personnel. For example, in 1940, President Franklin Delano Roosevelt hired 16 million soldiers to serve in the army during World War II, which was 30 % of a total labor force of 53 million (U.S. Census, 1940). The unemployment rate in the Great Depression (1929-1939) was 25% of the labor force, so WWII created full employment. A number of historians and economists (including me) opine that FDR willingly embroiled the U.S. in WWII in order to end The Great Depression. This theory may be hard to prove but the actions of FDR were certainly more than coincidental in 1940. While it is true that war was viewed as good for the economy in the past, ever since the end of the Vietnam War, the majority of economists now conclude the opposite. Consider the fact that three million U.S. soldiers served in Vietnam, but only 13,000 served in Afghanistan and only 5,000 in Iraq; that is not enough to affect the unemployment rate. In addition, the Afghanistan and Iraq wars cost over $3 trillion, money that could have been better used for domestic policy purposes.