Stronger Automatic Stabilizers Would Make Timely Stimulus The Norm
By Brendan McDermott
Congress responded to the pandemic recession with bold aid and stimulus programs that are fueling the economy’s impressive recovery. Yet lawmakers also set arbitrary expiration dates for many of those programs, such as the expanded unemployment insurance (UI) benefits that expire in September and the $350 billion aid program that state and local governments can use until 2024. These arbitrary dates risk ending aid well before — or after — the economy stops needing it.
To avoid these risks during future recessions, federal lawmakers should replace most ad hoc stimulus with stronger “automatic stabilizers,” stimulus programs that naturally adjust in size to the economy’s needs and can pay for their spending in downturns with savings during expansions.
Automatic stabilizers are government programs that benefit more people when incomes fall — such as UI and the Supplemental Nutrition Assistance Program — or those that grow more generous during downturns, such as the Extended Benefits program within UI that lengthens benefits by 13–20 weeks in states with high unemployment. Economic stimulus from automatic stabilizers is well-timed to ramp up at the start of downturns and wind down at the end because it responds directly to changes in peoples’ incomes or the unemployment rate. Timely stimulus can forestall layoffs early in a downturn without overheating the economy once it has recovered. As a result, automatic stabilizers dampened the severity of economic swings roughly as much as discretionary stimulus bills did between 1980 and 2018, according to experts at the Brookings Institution.
The enhanced stabilizers should include:
· Adjusting the size and duration of UI benefits when the unemployment rate changes, as President Biden has proposed, as well as expanding UI eligibility and paying for the costs across the business cycle by taxing higher incomes than UI does today.
· Increasing the federal share of Medicaid funding during recessions and reducing it during expansions.
· Providing matching funds for state and local infrastructure maintenance projects with a higher matching rate during downturns.
· Giving state and local governments direct aid during downturns, which could be paid for by making the cap on the regressive deduction for state and local taxes (SALT) permanent.
Lawmakers can always vote to spend more or less than automatic stabilizers prescribe, but strong stabilizers would mitigate changes in economic demand even if Congress failed to change aid policy quickly, as they often have during recent downturns. For example, Congress did not expand UI until six months after the Great Recession began, and Republicans let that expansion expire in 2013 even though nearly 4 million people were long-term unemployed.
As the pandemic lockdowns took hold last May, Congress passed the CARES Act more quickly, but interrupted that aid by creating and then missing self-imposed deadlines to extend the bill’s programs. Republicans let a $600/week UI benefit increase expire in July after claiming it discouraged work, even though few jobs existed for unemployed people to fill even if they wanted to. President Trump then let expansions of UI’s duration and eligibility lapse briefly in December 2020 when he temporarily refused to sign a bill extending the provisions into 2021.
Republicans also opposed sending federal aid to state and local governments to cover income and sales tax revenue shortfalls, even though those shortfalls forced cuts to essential services such as education. Congressional squabbles such as these would be less likely to undercut the recovery if automatic stabilizers were more robust.
Expand Unemployment Insurance
As part of his new American Families Plan, President Biden proposed making UI a stronger economic stabilizer by extending benefits for longer and making benefits larger during downturns but offered few specifics for doing so. PPI recently recommended increasing the share of a worker’s lost wages replaced by UI when a state’s 3-month average unemployment rate is both above 5 percent and rises by more than 1 percentage point in a year. This proposal would have provided roughly $190 billion in stimulus during the Great Recession and ensured that unemployment benefits never deterred work by exceeding the jobseeker’s lost income. Unemployment benefits would also be extended by 14 weeks in states with unemployment rates above 9 percent and 13 more weeks where rates surpass 10 percent.
State UI programs should use $2 billion made available by the American Relief Plan Act that President Biden signed in March to ensure their computer systems can quickly calculate and deliver these benefits. The federal government should support state modernization efforts further if this aid proves insufficient, possibly by creating their own computer systems that states can use.
PPI also proposes to provide unemployment benefits to more workers. For example, although self-employed workers are hard to insure through traditional UI because they often set their own schedules, lawmakers could let them defer taxes on savings for periods when they cannot work. Congress should also expand work-sharing programs, which give prorated benefits to workers who temporarily lose hours instead of their jobs. Only 26 states currently have work-sharing programs and employers often underutilize them. UI should pay for all these expansions across the economic cycle by taxing higher incomes than it does today.
Use Medicaid Matching Dollars to Moderate Fluctuations in State Revenues
Automatically ramping up direct federal aid to state and local governments should prove simpler than these UI reforms because Washington already has pre-existing channels to give states money through pre-existing federal-state partnerships, such as Medicaid. The federal government sent states $103 billion in aid during the Great Recession and $70 billion so far in the pandemic recession by increasing its share of the cost of Medicaid. That money not only freed up state funds for other spending priorities without creating a new bureaucracy, but also helped Medicaid cover laid-off workers who lost job-based health insurance. It makes sense to use the federal government’s ability to borrow at favorable rates to cover more of a state’s Medicaid costs when its unemployment rate rises, and less as its unemployment rate falls.
Provide Variable Matching Funds for Infrastructure Maintenance Projects
Since state and local governments may sometimes need more support than Medicaid can deliver, federal lawmakers should also pick up a greater share of intergovernmental infrastructure projects during downturns. President Biden recently proposed the federal government commit $1.3 trillion to rebuilding the nation’s physical infrastructure as part of his American Jobs Plan. Such an investment is badly needed, as the McKinsey Global Institute found in 2017 that the United States must raise infrastructure spending by 0.5 percent of GDP through 2035 — about $2.6 trillion — just to keep economic growth from slowing. Downturns exacerbate underinvestment because state and local governments often deal with budget crunches by pulling back their spending on infrastructure.
PPI recommends that federal lawmakers structure some of the President’s infrastructure investment as permanent new federal grants that match spending by state and local governments on infrastructure projects of national importance. Whereas local leaders will generally want to spend as much of the federal government’s money on their constituents as possible if it comes with no strings attached, requiring state and local governments to contribute some funding incentivizes them to pursue only useful projects. The matching rates for these grants should rise during recessions so state and local governments are encouraged to undertake deferred maintenance efforts when it is more cost-effective to do so and discouraged from discontinuing worthwhile long-term projects just because of temporary revenue losses.
These infrastructure grants could not only make the nation more productive in the long run but could also stimulate the economy in the short-term by creating well-paying construction jobs at times when the economy needs them most. Funding maintenance work would be especially stimulative, as such work can often begin more quickly than new capital projects can. Routinely maintaining infrastructure can also reduce the cost of future repairs and replacements. Yet despite these benefits, almost three-fourths of federal investment in water and transportation infrastructure went to new capital projects in 2017, leaving maintenance work to state and local governments. The federal government should focus more of its spending on maintenance at all times, but especially during downturns.
Cover Remaining State and Local Revenue Losses Directly
Finally, if state and local governments need more aid than these channels provide, the federal government should make up the difference through direct aid. Experts at the Tax Policy Center recently proposed creating a “State Macroeconomic Insurance Fund” that would automatically give state and local governments aid based on factors those governments cannot control, such as the unemployment rate. Unlike aid through federal-state partnerships, which states would need to pass through to local governments themselves, such a fund could also give to local governments directly.
TPC would encourage fiscal responsibility among state and local governments by letting them pay into the fund with any surpluses they run in good times in exchange for larger benefits during downturns. TPC would finance the rest of the fund’s benefits by making the $10,000 cap on federal income tax deductions for state and local taxes (SALT) permanent instead of allowing it to expire in 2025 as it would under current law. Although many Democrats from high-tax states want to repeal the cap, their efforts are deeply misguided: 56 percent of the benefit of ending it would go to the highest-earning one percent. Keeping the cap and using its revenues to give state and local governments direct aid would prevent regressive budget cuts during contractions instead of giving the rich a lavish tax cut.
These and other automatic stabilizers would make timely, proportional aid the default policy when Congress is too inflexible to act quickly. Ensuring the federal government automatically mitigates swings in economic demand will lessen the pain of downturns, spread the cost of stimulus across the business cycle, and free Congress to focus on addressing the unique issues each downturn presents.
