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A key issue in the congressional debate over President Biden’s Build Back Better (BBB) plan is how it would affect the economy over the next couple of years. Identifying precise effects is unusually difficult due to the economic circumstances stemming from the pandemic. But the bill’s overall short-run effects on both growth and inflation are likely to be small, despite the claims of both supporters and critics.
Here are some important factors to consider when you think about how the social spending, climate, and tax bill will affect the overall economy.
First, the economic impact will depend on the bill’s year-by-year net fiscal effects, not the ten-year net or gross cost.
Some politicians, highlighting the bill’s ten-year spending totals, have argued that the new spending will add to inflation, but that ignores the offsetting effects of the bill’s higher taxes. Others say that because tax cuts and spending increases in the bill are largely paid for with tax increases, the bill will have little effect on aggregate demand, and therefore little impact on output or inflation.
However, it is important to remember that the bill’s tax cuts are front-loaded, while the tax increases largely would occur in later years. For example, the Joint Committee on Taxation estimates the bill would reduce revenues by over $100 billion in fiscal year 2022 but raise revenues by nearly $200 billion annually starting in 2027.
Much of the new spending would be slow to go out the door, but it would nonetheless boost demand over the next few years. In addition, most of its tax cuts would flow to lower- and middle-income households who tend to spend more of their after-tax income. But most of the tax increases would fall on high-income households, who tend to spend less. That mix also would increase demand.
That said, the economic impact of fiscal policy on the scale of Build Back Better would be modest. For example, a 2022 fiscal boost in the $200 billion range represents less than 1 percent of Gross Domestic Product (GDP).
Given such small economic side effects, the desirability of the plan should be judged mainly on its direct effects—such as potentially raising children out of poverty or promoting cleaner forms of energy—rather than its indirect effects on the economy.
Aside from the small impact, it’s uncertain whether stimulating today’s economy would be good or bad. Due to the effects of COVID-19, the economy is still almost a percent below its pre-pandemic path, and employment lags by much more. Additional stimulus would help increase output and employment.
However, the past year also has seen rapid and concerning growth in inflation. More stimulus would increase prices and wages but also likely by only a tenth of a percent or two.
The source of current inflation is unclear. Inflation results from an imbalance between demand and supply, but that imbalance can stem from changes in either side of the equation. Some analysts argue that the various pandemic relief programs have raised demand above supply. However, the pandemic also created production problems that restricted the supply of goods. The well-known shortage of computer chips is an example. The distinction is important largely because the supply bottlenecks should fade once the pandemic dissipates.
The labor market provides some clues to the source of inflation, but they are not consistent. On one hand, the high number of workers quitting their jobs suggests a tight job market. On the other, overall employment remains about 4 million below its pre-pandemic level.
If workers are leaving their jobs mainly to find different types of work, the decline in employment should be transitory. However, if the pandemic permanently discouraged people from working at prevailing wages, pressures will grow on wages and prices.
So far, real (inflation-adjusted) wages have fallen rather than risen over the past year. That is, indexes for wages and salaries and for broader compensation have increased by less than the price level. That does not appear to indicate inflationary pressure in the labor market.
Supporters of the BBB bill insist the bill will create an economic boom and help workers manage price increases. Critics say it will only worsen inflationary pressures. In reality, both are overstating its effects.
Correction: An earlier version of this blog mischaracterized the size of proposed stimulus as 0.1 percent of GDP rather than less than 1 percent of GDP.
Posts and comments are solely the opinion of the author and not that of the Tax Policy Center, Urban Institute, or Brookings Institution.
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