‘Multiplier effect’ is poor justification for increased government spending

Hawaii lawmakers must not be afraid to cut the state budget
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By Joe Kent, Ken Schoolland, Per Bylund and Victor V. Claar

In the rush to mitigate the economically devastating impact of Hawaii’s state-mandated shutdown, many lawmakers and policy wonks have been invoking “the multiplier effect.”

For example, when Gov. David Ige announced in early April he was considering cutting public employee salaries by 20%[1] — to balance the estimated $1.5 billion drop in state tax revenues[2] — some opponents countered that every $1 dollar of government spending has a “multiplier effect” of $1.50 in downstream economic activity, so the state should keep spending.[3]

Despite almost 40% of Hawaii’s workforce being unemployed, they also suggested a variety of possible tax increases, and held out hope that Hawaii might be able to secure emergency loans from the federal government, which allegedly “has vast borrowing capacity without balanced-budget restrictions.”[4]

Nevertheless, Ige did have the right idea, and if Hawaii’s lawmakers wish to save our state economy from its current freefall, they must not be afraid to reduce state spending.

The multiplier effect, of course, was popularized by British economist John Maynard Keynes, and is a standard argument for evermore government spending.[5] The multiplier effect is so significant, its advocates argue, that it’s worth it for Hawaii to borrow up to $4 billion dollars from the federal government and repay it over two years by implementing temporary additional future taxes on Hawaii residents.

But many economists dispute the so-called multiplier effect, holding that government spending more typically hinders economic growth, partly by crowding out private borrowing.[6] This, in turn, depresses capital investment by the private sector, which is the true source of economic growth.[7]

As economist Milton Friedman famously used to say, “There ain’t no such thing as a free lunch.”[8] In other words, the money that a government spends has to come from somewhere. And if it isn’t obtaining it directly from the taxpayers, it’s borrowing it for taxpayers to pay in the future, with interest.[9]

Of course, if you are the federal government, you also can simply print money out of thin air, but that causes inflation and reduces the purchasing power of money for everyone — a hidden tax, essentially.[10]

So basically, asking our cash-strapped federal government to lend us money — which it would have to do through borrowing of its own and printing money out of thin air — is basically a beggar-thy-neighbor policy that would shift some of the burden of our spending to people in other states, in exchange for higher future taxes, both state and federal, and the hidden tax of inflation nationwide.

Not only that, when Hawaii’s state and county governments spend, they often do so wastefully — on megaprojects such as the over-budget, behind-schedule Honolulu rail; on bureaucratic bloat; or on inefficient services that the private sector could be delivering at a higher level of quality for lower cost.[11]

That’s why tax cuts can boost an economy, because the dollars are kept in the private sector and used more productively.[12]

Keynesians counter that the boost from $1 of spending is more than a $1 tax cut because the taxpayer being allowed to keep his or her own money will save a portion of that, and saving is bad because it is “leakage” from the economy.[13] They argue that a dollar saved is a dollar wasted or, at least, a dollar not spent in the economy.

However, this ignores the fact that savings are not hidden in people’s mattresses. Savings are borrowed by investors, and thus spent in productive ways for future growth, rather than immediate consumption. Savings help the economy in the long run because the money is directed toward more productive activity. For example, saving for a future college education might be more productive for an individual than spending now on a surfboard.

Economist Dan Mitchell even argues that the multiplier effect of government spending is actually negative, since many government actions hinder economic growth of the economy through regulatory barriers.[14] This should compel lawmakers to cut regulations swiftly so as to reduce economic hurdles.

Such barriers also contribute to Hawaii’s high cost of living, magnifying the cost of housing, food, healthcare and all other goods and services “essential” to our lives.[15]

For the healthcare industry particularly, our lawmakers could eliminate the state’s “certificate of need” laws for new medical facilities,[16] exempt healthcare providers from the state’s general excise tax,[17] and retain Ige’s edicts that sanctioned telemedicine[18] and allowed doctors and other healthcare providers from other states to practice in Hawaii.[19]

They could also lobby the federal government to reform the protectionist maritime law known as the Jones Act, which adds to Hawaii’s high cost of living, and which, at the moment, is politically vulnerable.

Something else to consider is that Hawaii’s fiscal 2021 general fund budget is $8.7 billion.[20] A 20% cut would shrink it to the fiscal 2015 level of $6.9 billion, adjusted for inflation.[21] That means today’s taxpayers are paying an extra $1.7 billion annually to provide public services for fewer people.[22]

Lawmakers should have saved those windfall dollars for a rainy day, as we at the Grassroot Institute warned many times.[23]

Instead, they spent their reserve funds on growing department budgets, payroll increases and other nonemergency items.[24] This fiscal irresponsibility reduced the capacity of government to handle the hard times today.

It’s time for Hawaii’s government to face the hard fact that cutting government spending is the only way to put money back into the economy without saddling taxpayers with extra burdens.

It is surely reasonable that as taxpayers are forced to tighten their belts, so should the public servants who are dependent on them.

Shrinking Hawaii’s government spending by 20% would still allow for satisfactory public services for residents —especially if private contracting of public services were encouraged — while keeping enough money in taxpayer pockets to sustain economic growth now and in the future.
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[1] Kevin Dayton, “Gov. David Ige proposes 20% pay cuts for teachers, other Hawaii public employees” Honolulu Star-Advertiser, April 15, 2020, www.staradvertiser.com/2020/04/15/breaking-news/gov-david-ige-proposes-20-pay-cuts-for-teachers-other-state-employees/.
[2] Nancy Cook Lauer, “Ige considering pay cuts as state faces $1.5 billion shortfall because of pandemic” Hawaii Tribune-Herald, April 16, 2020, www.hawaiitribune-herald.com/2020/04/16/hawaii-news/ige-considering-pay-cuts-as-state-faces-1-5-billion-shortfall-because-of-pandemic/.
[3] “Avoid public sector cuts at all costs during a recession,” Hawaii Budget and Policy Center, April 2020, https://hibudget.org/2020/04/avoid-public-sector-cuts-recession; Carl Bonham, et al., “Tap Fed Lending Facilities to Support Local Economy,” The Economic Research Organization at the University of Hawaii, April 21, 2020, https://uhero.hawaii.edu/tap-fed-lending-facilities-to-support-local-economy; “HSTA, AFSCME, HGEA offer governor 15+ alternatives to public worker pay cuts,” Hawaii State Teachers Association, HSTA.org, April 23, 2020, www.hsta.org/News/Recent-Stories/hsta-afscme-hgea-offer-governor-15-alternatives-to-public-worker-pay-cuts; and letter to Gov. David Ige, from Randy Perriera, executive director of the Hawaii Government Employees Association, April 21, 2020, www.hgea.org/Media/4227/lettertogovigeapr212020.pdf.
[4] Carl Bonham et al., “Tap Fed Lending Facilities to Support Local Economy,” University of Hawaii Economic Research Organization, April 21, 2020.
[5] “Keynesian Multiplier,” Corporate Finance Institute, 2020, https://corporatefinanceinstitute.com/resources/knowledge/economics/keynesian-multiplier.
[6] Olivier J. Blanchard and Daniel Leigh, “Growth Forecast Errors and Fiscal Multipliers,” National Bureau of Economic Research, February 2013, www.nber.org/papers/w18779; Scott Sumner, “Why the Fiscal Multiplier is Roughly Zero,” Mercatus Center, George Mason University, Sept. 11, 2013, www.mercatus.org/publications/monetary-policy/why-fiscal-multiplier-roughly-zero; and Dan Mitchell, “The Impact of Government Spending on Economic Growth,” The Heritage Foundation, March 15, 2005, www.heritage.org/budget-and-spending/report/the-impact-government-spending-economic-growth.
[7] “Crowding out (economics), Wikikpedia, https://en.wikipedia.org/wiki/Crowding_out_(economics).
[8] Stephen Moore, “The Man Who Saved Capitalism,” The Wall Street Journal, Aug. 1, 2012, www.wsj.com/articles/SB10000872396390444226904577558882802335216.
[9] Robert F. Mulligan, “The Central Fallacy of Keynesian Economics,” Quarterly Journal of Austrian Economics, Mises Institute, Nov. 19, 2014, https://mises.org/library/central-fallacy-keynesian-economics-0. See also, James C. W. Ahiakpor, “On the Mythology of the Keynesian Multiplier: Unmasking the Myth and the Inadequacies of Some Earlier Criticisms,” American Journal of Economics and Sociology, Vol. 60, No. 4, October 2001, pp. 745-773; www.jstor.org/stable/3487835?seq=1; Andrew Beattie, “Free Market Maven: Milton Friedman,” Investopedia.com, June 25, 2019, www.investopedia.com/articles/economics/09/milton-friedman.asp; and Peter G. Klein, “More Bad News for the Keynesian Multiplier,” Mises Institute, April 30, 2015, https://mises.org/wire/more-bad-news-keynesian-multiplier.
[10] “Definition of Inflation Tax,” Financial Web, 2018, https://www.finweb.com/taxes/definition-of-inflation-tax.html; and Kevin Mercadante, “Inflation Is A Hidden Tax — What Can You Do About It?” Investor Junkie, https://investorjunkie.com/economics/inflation-hidden-tax.
[11] According to economist Milton Friedman, “Government expenditures simply divert private expenditures and only the net excess of government expenditures is even available at the outset for the multiplier to work on. From this point of view, it is paradoxical that the way to assure no diversion is to have the government spend the money for something utterly useless — this is the limited intellectual content to the ‘filling-holes’ type of make-work.” Milton Friedman, “Capitalism and Freedom,” University of Chicago Press, Chicago, 1962, pp. 80-81, https://tinyurl.com/ya23p6zx.
[12] Dan Mitchell, “The Impact of Government Spending on Economic Growth,” The Heritage Foundation, March 15, 2005, www.heritage.org/budget-and-spending/report/the-impact-government-spending-economic-growth.
[13] Robert F. Mulligan, “The Central Fallacy of Keynesian Economics,” Mises Institute, Nov. 19, 2014, https://mises.org/library/central-fallacy-keynesian-economics-0.
[14] Dan Mitchell, “The Impact of Government Spending on Economic Growth.”
[15] Joe Kent, “18 ways to help Hawaii get back on its feet,” Grassroot Institute of Hawaii, April 19, 2020, www.grassrootinstitute.org/2020/04/18-ways-to-get-hawaii-back-on-its-feet.
[16] Certificate of Need,” State Health Planning & Development Agency, Hawaii Department of Health, 2020, https://health.hawaii.gov/shpda/certificate-of-need, and Denis Mannschatz, “Hawaii doesn’t need ‘certificate of need’ laws,” Grassroot Institute of Hawaii, Nov. 7, 2017, www.grassrootinstitute.org/2017/11/hawaii-doesnt-need-certificate-of-need-law.
[17] “How Hawaii’s GET adds to island healthcare costs,” Grassroot Institute of Hawaii, January 2020, www.grassrootinstitute.org/wp-content/uploads/2020/02/GET-Report-complete.pdf.
[18] “Sixth supplementary proclamation amending and restating prior proclamations related to the COVID-19 emergency,” Office of the Governor, State of Hawaii, pp. 23-24, 27 and 31, https://governor.hawaii.gov/wp-content/uploads/2020/04/2004144-ATG_Sixth-Supplementary-Proclamation-for-COVID-19-distribution-signed.pdf.
[19] Ibid, p 27.
[20] “The FY 2021 Executive Supplemental Budget,” Hawaii Department of Budget and Finance, Dec. 16, 2019, p. 3, https://budget.hawaii.gov/wp-content/uploads/2020/01/Budget-in-Brief-FY-21-BIB.pdf.
[21] “State of the State Budget 2020,” Grassroot Institute of Hawaii, March 2019, p. 32, https://www.grassrootinstitute.org/wp-content/uploads/2019/03/State-of-the-State-Budget-2020.pdf.
[22] “Annual Estimates of the Resident Population for Counties in Hawaii: April 1, 2010 to July 1, 2019,” U.S. Census Bureau, Population Division, March 2020, https://census.hawaii.gov/wp-content/uploads/2020/03/co-est2019-annres-15.pdf.
[23] “State of the State Budget 2020,” Grassroot Institute of Hawaii, March 2019, p.5, https://www.grassrootinstitute.org/wp-content/uploads/2019/03/State-of-the-State-Budget-2020.pdf. See also, “State of the State Budget 2017,” Grassroot Institute of Hawaii, Spring 2017, p. 3, https://www.grassrootinstitute.org/wp-content/uploads/2017/03/State-of-the-State-Budget-2017.pdf.
[24] Ibid.
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Joe Kent is executive vice president of the Grassroot Institute of Hawaii, Ken Schoolland is a Grassroot Scholar and associate professor of economics at Hawaii Pacific University, Per Bylund is assistant professor of entrepreneurship at Oklahoma State University, and Victor V. Claar is associate professor of economics at Florida Gulf Coast University.