The Economic Impact of Federal Spending on State Economic Performance


Read full report | EXECUTIVE SUMMARY: Federal government spending comes with costs; it should not be accepted as the free-lunch it is frequently considered to be. Every dollar the government spends must first be removed from the pocket of the private sector – through higher taxes today, or higher borrowing today implying higher taxes tomorrow. Either way, government spending crowds out private sector spending, diminishing the private economy’s rate of growth. In other words, increased government spending makes citizens poorer because it takes their money now while reducing their future income.

The impact of accepting unemployment insurance (UI) funds from the ARRA is particularly subject to discussion. UI expenditures increase during a recession, which often drains state trust funds. Historically, the federal government steps in to cover the increased costs, but with strings that require expanded UI benefits. Once the temporary federal money has run dry, states have historically been forced to ramp up their collections in order to maintain the additional support previously provided by the federal government.

Properly accounting for the impact from higher government expenditures illustrates the negative economic impacts high or increasing expenditures have. Total government expenditures relative to the private economy – known as the government expenditure wedge – appropriately measures the burden created by total government spending. The government expenditure wedge is determined by dividing government expenditures by net domestic business output.

The historic relationship between the growth in the private economy, the size of the government expenditure wedge, and the change in the government expenditure wedge illustrates that increases in government spending relative to the size of the private sector causes a reduction in the overall growth of the economy.

For example, between 1965 and 1983, the government expenditure wedge grew quickly, rising 16.6 percentage points to 49.0%. Growth in the private sector slowed to 2.5% per year.

On the other hand, between 1983 and 1988, growth in the private sector accelerated to 5.1% per year as the government expenditure wedge fell 3.3 points back down to 45.7%.

Consequently, the costs of accepting federal dollars from the American Recovery and Reinvestment Act (ARRA) of 2009 will be a long-term drain on the private sector. The ARRA Act of 2009 will increase the government expenditure wedge from 49.16% to 52.41% for an overall 3.25% increase. This increase will reduce the growth in real net business output by 2.5%, which translates to a reduction of 1.7 million jobs nationally – of which between 7,600 and 10,400 jobs will be lost in Maine.

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