Last week, President Biden outlined his plan for infrastructure spending and other priorities. Currently, the most likely scenario is that nearly all of the approximately $2 trillion in proposed spending will pass. Due, in part, to expectations for further historically large fiscal stimulus on top of existing historically large stimulus, markets are now pricing in over 25 basis points of Federal Reserve hikes by the end of 2022 and four hikes by the end of 2023. In contrast, the Fed’s dot plot shows rates near zero though 2023.
The reason why nearly all of the proposed spending is expected to be approved is threefold. First, the U.S. desperately needs to improve its infrastructure, with the World Economic Forum ranking the U.S. 13th in the world in the quality of its infrastructure. Second, infrastructure spending is popular. Recent opinion polls found that 74% of Americans support infrastructure spending if it is paid for with a wealth tax. However, this support drops to 32% if it is paid for with a gas tax. Third, with Democrats controlling Congress and the White House, there won’t be a debate over who gets “credit” for the plan. The unified government should also make funding easier, as there is consensus among Democrats to fund part of the plan through taxes on high income people and/or corporations. Moreover, infrastructure is the kind of legislation that is able to bring along reluctant support with earmarks.
As with the recent stimulus package, focus should swiftly shift to a Democrat-only plan that uses the “reconciliation” process instead of the “regular order” that can be filibustered in the Senate. Using reconciliation means Democrats will have to wait until October when the new fiscal year starts. The current plan is designed to be deficit neutral over a 15-year period, with the deficit increasing over the first eight years but decreasing over the last seven years. The tax portion of the proposal is also expected to be watered down to accommodate moderate Democrats who want to pay for infrastructure through higher taxes but don’t want a major tax increase.
Regarding the economic impact, infrastructure spending has two different short- and long-run impacts. In the short run, the economic impact primarily comes through an increase in aggregate demand, as big spending increases are only offset by small tax increases. Even if spending is matched dollar for dollar with tax increases, overall demand should increase, as government spending has a higher multiplier effect than taxes. In fact, one of the key selling points of infrastructure is that it’s job creating rather than job shifting.
Supply-side benefits, however, take more time to play out. The immediate flow of investments drives aggregate demand, but it is the buildup of new capital that drives aggregate supply. Moreover, public investments can also reduce productive activity in the private sector, as it disrupts that activity. As such, the supply-side benefits of infrastructure spending come over the long run. The benefits of green investments could take even longer. The key near-term benefit of green investment is a healthier environment, but the benefit to economic output comes later, hopefully through mitigating climate change and the supply shocks that come with weather and other disruptive events.
Of course, the choice of projects also matters. Most studies find that the highest return comes from the least-inspiring part of infrastructure spending — maintenance and repair. So it makes a big difference if funds are allocated on a cost-benefit analysis basis or through politically determined earmarks. | |
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