HOW TO TAKE CHARGE OF A TWO-SPEED STIMULUS / THE FINANCIAL TIMES COMMENTARY & ANALYSIS ( RECOMMENDED READING )

How to take charge of a two-speed stimulus

By Felix Rohatyn and Everett Ehrlich

Published: July 29 2009 21:41

The conventional wisdom both in Washington and on Wall Street is that the stimulus package passed last spring has been slow to feed through into spending, leaving the economy to founder in the interim.

But the reality is more complex. Some of the stimulus has been slow to take effect, particularly the part related to the nation’s infrastructure. But another component – fiscal assistance to the states – has raced through the policy apparatus faster than might have been expected.

It is tempting to blame the failure to spend infrastructure funds expeditiously on the inherent nature of “big ticket” projects. The reality is that it is a failure of policy. As we have said on these and other pages, our federal policies treat infrastructure as a way to give states and localities resources to pay for projects that meet local, political objectives rather than national, economic ones.

We have proposed replacing individual infrastructure trust funds and programmes – highways, airports, ports and navigation, mass transit, and the like – with a National Infrastructure Bank. The National Governors Association, the collective voice of US state governors, only this week endorsed a bill by Congresswoman Rosa DeLauro that embodies this concept. The NIB would evaluate all prospective infrastructure projects on consistent terms and negotiate the federal role, if any, case-by-case, blending government and private money to fund all candidate projects with internal rates of return above some threshold.

Such an institution would allow the government to have a queue of “shovel-ready” projects; if it should then announce that it was prepared to lower the rate-of-return threshold for funding from, say, 15 per cent to 13 per cent, not only would it have a list of projects ready for funding, but we would have confidence that the added projects were the best available.

The administration has circulated ideas about a prospective bank of this sort with relatively small initial funding; and that is a step in the right direction. The NIB could improve the way we invest, what we invest in, and the ability of infrastructure to perform a counter­cyclical mission.

But if infrastructure money has been slow to feed through to spending, the one-third of the $787bn (€553bn, £478bn) stimulus that went to state governments has travelled at the fiscal speed of light. With the exception of about $43bn of revenue specified for 2010 Medicaid payments, it has largely all been spent.

This means the fiscal hole in which our states find themselves is large and growing. The 50 states combined face a $200bn shortfall over the next three years, despite the deferrals, cuts and tax increases ($24bn of the last already this year) that have occurred so far. That $200bn is 10 per cent of the general fund spending that the 50 states undertake each year.

The problem is not state profligacy but, rather, a collapse in income tax revenues driven by cyclical economic conditions, for one, and the collapse of capital gains tax realisations. The Rockefeller Institute calculates that the taxes collected by all 50 states fell by 12 per cent in the first quarter of this year, compared with a year ago. But even if the economy recovers later this year, itself far from a certainty, the states’ fiscal imbalance is likely to continue. As budget experts understand, state deficits lag behind recoveries, in part because unemployment is the last aspect of a downturn to be corrected, and in part because the states’ primary expenditure – Medicaid – continues to grow as the victims of the recession turn to it when they run out of other options.

The Congress, therefore, should prepare an extension of last spring’s stimulus to plug the states’ fiscal hole. Block grants worth $100bn should be readied for late this year, one-third to go directly to our largest localities and allocated using not just measures of population, but changes in employment or other gauges of current economic conditions. Another $30bn should support extended unemployment benefits and food stamps, administered by the states but paid for by the federal government.

And the Congress should take the legislative proposals it now has and create a National Infrastructure Bank. Such an entity would give us a list of projects that were not only shovel-ready, but shovel-worthy.

We are confident our economy’s resilience will inevitably bring it out of this profound downturn. The administration and the Congress should share that confidence. But the best way to act on that belief is to take the steps that will hasten that upswing, and it will take more than we have done to date.

Felix Rohatyn is an investment banker and former chairman of New York’s Municipal Assistance Corporation. Everett Ehrlich is president of ESC Company, an economic consulting firm, and was undersecretary of commerce in the Clinton administration

Copyright The Financial Times Limited 2009