Obama's "New Deal" will give growth crucial boost

WASHINGTON (Reuters) - President-elect Barack Obama has promised the country's biggest-ever public works program to help lift the U.S. economy out of recession, but some fiscal policies get a bigger bang for the federal buck than others.

Economists expect Obama to quickly sign a multi-year spending package, after taking office on January 20, 2009, that could be worth up to $750 billion, or almost 5 percent of U.S. GDP.

This might add over $1 trillion to the economy over time, depending on how it is spent. Alongside muscular action by the U.S. Federal Reserve, this would help to steady a downturn that is already the ugliest since the 1980s and may yet get worse.

"Massive fiscal stimulus is coming," wrote Morgan Stanley economists Richard Berner and David Greenlaw, who estimate it will help limit the contraction in the U.S. economy next year to 1.9 percent and restore growth to 2.0 percent in 2010.

Anticipation that a fiscal boost will shorten an already year-long recession has stemmed steep stock market losses. But there are no details of what Obama's team will put on the table, and there is substantial debate about what works best.

More money in people's pockets lifts economic activity to the extent that it is spent. Some programs get that money out the door faster than others, and into the hands of people more likely to buy rather than save.

As a result, direct spending by government is generally seen to deliver a bigger bang than tax cuts because it is all spent.

"There is a pretty firm consensus that direct spending will tend to be more effective than tax rebates -- give people a rebate and they'll just save," said Kenneth Kuttner, an economics professor at Williams College in Massachussetts.

But tax cuts can be easier to implement quickly, and depending on which taxes are targeted, can aim aid at poorer families more likely to spend it than richer Americans.

"Officials could implement a six-month suspension of the payroll tax quickly and inject $425 billion into the economy," the Morgan Stanley economists said. Payroll taxes finance Social Security and Medicare.

BANG FOR BUCK

Every extra dollar put into the economy also has knock-on benefits for broader activity, or what economists call 'multipliers,' that amplify the addition to growth over time.

Investment in the country's so-called capital stock, which is anything that can be used to enhance production or productivity, can get a really big bank for the federal buck, but often takes years to fashion and deliver.

Obama vowed on Saturday to "create millions of jobs by making the single-largest new investment in our national infrastructure since the creation of the federal highway system in the 1950s."

This was a reference to the interstate highway system initiated in 1956 by President Dwight Eisenhower, a project that took almost 40 years to complete. It is also not clear how many projects are actually 'shovel ready' right now in terms of being planned out and ripe to roll.

"Investment in infrastructure will have a longer-term payback in increased output because we're increasing the nation's stock of capital (but) there is a substantive debate over the size of this long-term impact," said Menzie Chinn, a professor of economics at the University of Wisconsin.

"How much more efficient is the economy when you have to spend an hour less time in traffic, or you don't have to shut down a (part) of a city because the sewer pipes have collapsed," he said.

In congressional testimony in July, Mark Zandi, chief economist of Moody's Economy.com, laid out the multipliers that he estimated applied to range of measures from tax cuts to government spending.

Zandi found that tax cuts delivered the least bang for the buck, with a dollar's worth of a temporary nonrefundable tax rebate worth $1.02 with a one-year lag. Permanent tax cuts yielded less than 50 cents of additional spending.

In contrast, actual spending increases were worth $1.36 if they were disbursed as aid to state governments; $1.59 if the money went on infrastructure; $1.64 for extended unemployment benefits and as much as $1.73 from an increase in food stamps.

"The money goes to people who have already suffered a decline in their standards of living and pretty much all of it gets spent," said Chad Stone, chief economist at the Center on Budget and Policy Priroties, a liberal Washington-based think tank.

If the federal government wants to make a more general contribution to the economy it can subsidize cash-strapped state and local governments.

Stone estimates state governments currently face operating budget shortfalls of $200 billion to $250 billion as the recession saps revenues from taxes. Most states are required by law to balance their budgets, and many have already begun cutting back on important social services.

"If you can give them the funds that allow them to avoid making cuts in spending without increasing taxes, that can... lead to pretty good outcomes," he said.

(Reporting by Alister Bull)