Silver Lining on the Horizon

Update 391 — Silver Lining on the Horizon
(How) Do Automatic Stabilizers Really Work?

Economists now speak of the next recession in terms of when, not whether.  As the recession approaches ever closer, so too do increases in fiscal stimulus known as  “automatic stabilizers,” such as unemployment insurance, representing a silver lining. 

How do these triggers work, and do they work?  Per our indicator series last week, some metrics lead and others lag the macroeconomy.  And reaching statutory triggers may represent good news or bad news depending on macroeconomic context.  Designed to mitigate recessions and not to prevent them, is this design the optimal use of the stabilizers?

Our next update will cover this week’s Progressive Strategy Summit, hosted by the Congressional Progressive Caucus Center. The Summit is tomorrow and Friday, Oct. 24-25, at the D.C. Hyatt Regency.  Plenty of progressive policy proposals and plans to take into 2020…




Fiscal Context

Last week, the House Budget Committee held a hearing entitled, “Strengthening Our Fiscal Toolkit: Policy Options to Improve Economic Resiliency.”  

During the hearing, Chair Yarmuth argued that the automatic stabilizers currently in law can only do so much, and that Republican attacks on government assistance programs such as the Supplemental Nutrition Assistance Program (SNAP) will mean less assistance will be available for Americans during the next crisis. Ranking Member Womack argued that public assistance programs are too costly and that the real focus should be on preventing a future recession — through deregulation and tax cuts. 

The Tax Cuts and Jobs Act (TCJA) famously reduced federal revenue and increased budget deficits substantially. Its short-lived fiscal stimulus has left the economy and monetary policy stuck in low-interest, low-growth mode. Fiscal policy is theoretically constrained as a result in the event of an economic downturn.  

Holding other fiscal stimulus equal, can and should automatic stabilizers be designed to prevent rather than soften the blow of the next recession?  

What are Automatic Stabilizers?

In theory, during times of strong economic growth, federal revenue rises and budget deficits shrink; conversely, during a downturn, federal spending should rise to offset muted aggregate demand in the private sector. So-called automatic stabilizers in the economy act to dampen or bolster economic growth during times of expansion and contraction, respectively. 

Critically, automatic stabilizers operate without government action. For example, transfer payments such as unemployment insurance, food stamps (SNAP), and other formula-based entitlement programs pay out more during a recession as more people qualify for benefits. Progressively-structured personal income tax rates are another example, as marginal tax rates decrease as incomes fall. 

Automatic stabilizers are proven to be effective. According to the CBO, the stabilizers helped improve economic activity by over $300 billion a year between 2009 and 2012. Given their stimulative significance, it is worth considering whether and, if so, how they could operate prophylactically.  

(How) Can the Stabilizers be Improved?

Automatic stabilizers can easily be made to pay for themselves and more effectively head off or blunt oncoming downturns by goosing aggregate demand. What more should we ask from automatic stabilizers? Can stabilizers be more optimally triggered by changes in macroeconomic data or or be better timed to kick in? We drill down, looking at unemployment, SNAP, and the Temporary Assistance for Needy Families (TANF) benefits. 

  • Unemployment Insurance (UI): The last recession lasted longer than the recessions of 1991 and 2001 but, like them, led to a ‘jobless recovery.’  Unemployment did not return to pre-recession levels until years after the recession officially ended. Policymakers could therefore prepare for similar conditions next time around and adjust accordingly; unemployment benefits should be prolonged, and Congress can and should act now to ensure ‘extensions’ should kick in early and automatically. 

    Congress could also enhance the value of the benefit itself and exclude UI benefits from income tax liabilities. Furthermore, with current unemployment levels at record lows, this new normal should be reflected how and when the automatic stabilizer is triggered. 
  • Assistance to Families: Two programs, SNAP and TANF, provide much-needed assistance to low-income households. SNAP (formerly known as the Food Stamp Program) is a textbook automatic stabilizer: if a household’s income dips below 130 percent of the poverty level, SNAP eligibility kicks in and benefits are available immediately. 

    During past recessions, Congress has enhanced SNAP benefits — this process could be automated, and given the political paralysis in Congress, it probably should as a precaution. One problem with SNAP is the stringent work requirements, which cut against SNAP’s key automatic stabilization effect and do not reflect the slower employment recoveries of the last three decades. TANF is currently not considered an automatic stabilizer because block grant programs do not automatically expand benefits when needs increase, but it could be made into one. TANF benefits could kick in automatically like SNAP. 

States, Localities, and We Offer Modifications 

One key element of the American Recovery and Reinvestment Act (ARRA) during the Great Recession was new infrastructure spending. Over $48 billion was spent putting Americans back to work making repairs and supporting long-term transformative investments across every state.  The federal government evaluates the merit of infrastructure project proposals through the Department of Transportation’s Better Utilizing Investments to Leverage Development (BUILD) program. Congress could authorize additional funding to the BUILD program — not to spend immediately — so that resources could be set aside and more applications could be approved during times of high unemployment or low growth (whatever the desired trigger would be).

Housing was a principal cause of the last recession. Unemployment can lead to poverty, missed mortgage payments, and home foreclosures, constricting demand. The Homelessness Prevention and Rapid Re-Housing Program (HPRP) provides financial assistance and other services to families in danger of becoming homeless. Federal funds are provided to state governments. The program ended up serving more than 1.3 million people during its three years of operations. Making the HPRP permanent and pegging it to an indicator like foreclosure rates might be worth Congressional consideration. 

As medical costs continue to outstrip wages, an economic recession hits those with medical debt particularly hard. It will also affect state governments; more Americans will qualify for needs-based government assistance programs, constraining states as they seek to cut spending to meet balanced budget rules amid falling revenues.

The Federal Medical Assistance Percentages formula (FMAP) is another model to look at. FMAP was introduced as part of ARRA — it is triggered by spikes in the unemployment rate and provides relief to state governments dealing with Medicaid and the Child’s Health Insurance Program budget shortfalls. Making FMAP permanent and more generous would go far towards reducing state-level austerity measures that aggravate economic downturns. 

Review the Metrics, Review the Mission

Automatic stabilizers have a role to play in aiding recovery and making sure the next recession is swift and not as severe as it might otherwise be. 

But to the extent it is successful in this role, it begs the question whether it could do more. Authorizing a statutory review and adjustment to the stabilizers program — enabling tweaks to the triggers — to reflect macroeconomic circumstances can perhaps turn an ounce of cure into a pound of prevention. 

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