WASHINGTON – Just as the Federal Reserve is pulling back slightly on the economic accelerator, Congress is pressing down a bit harder.
The spending and tax-cut package that Congress approved Friday stands to modestly boost growth next year. It could also help drive a shift away from government as a drag on economic growth to a source of potential stimulus.
“This shift … is currently being overlooked by financial markets and analysts,” said Joseph Carson, U.S. economist at asset manager Alliance Bernstein. “But we believe this will be a key aspect of a more positive and faster growth environment for next year.”
Economists at Goldman Sachs have forecast that increased federal spending and tax cuts should add to economic growth in 2016 for the first time in six years.
The $1.1 trillion budget deal boosts spending for most Cabinet agencies by about 6 per cent next year. A separate tax measure provides $680 billion in tax cuts over 10 years. It would do so mostly by extending or making permanent about 50 different expiring tax breaks.
That measure follows Congress’ approval of a five-year, $305 billion highway bill earlier in December.
Taken together, the measures could increase growth to about 3 per cent next year, Carson estimates, up from a likely pace of about 2.25 per cent this year.
Alec Phillips, an economist at Goldman Sachs, forecasts a smaller gain and envisions overall growth next year of 2.25 per cent.
The picture now looks brighter for state and local governments, too. Their tax revenue has increased as the economy has improved. The economy now has about 4.5 million more jobs than it did before the Great Recession began in late 2007.
Spending on construction at all levels of government, for example, rose 6.1 per cent in October compared with a year earlier. Additional government spending can also translate into more purchases of military equipment.
The economic lift from government, if it proved significant and if it raised undesirably low inflation, could make it easier for the Fed to continue raising short-term interest rates. On Wednesday, citing the improved economy, the Fed announced its first rate increase in nine years. For seven years, the central bank had kept its key short-term rate at a record low near zero to encourage borrowing and spending.
Fed Chair Janet Yellen’s predecessor, Ben Bernanke, had frequently called on Congress to limit its budget cuts in the short run to help the economy recover. But in recent months Yellen has noted that governments at all levels were spending a bit more. That likely helped set the stage for the Fed’s rate increases.
“Fiscal policy actions at both the federal and the state and local levels look like they are no longer a significant drag on economic growth,” Yellen said in May.
The Fed said Wednesday that any rate hikes next year would likely be gradual and that it may delay further increases if the economy weakens. The Fed’s interest rate target will likely remain below its longer-run average all next year, Yellen said, meaning that consumer borrowing rates should also remain at historically low levels.
Business groups applauded Congress’ extension of tax credits, particularly those that enable companies to write off their expenses for big-ticket purchases and research and development expenses.
They have long complained that the temporary nature of those tax breaks meant companies couldn’t be sure they would be available. Next year will be the first year since 2013 that companies will start the year knowing that the credits will be available, Phillips noted.
“Fiscal instability and uncertainty in the tax code have stifled investment for years,” said Mark Weinberger, CEO of consulting firm EY and chair of the Business Roundtable, a group of large company CEOs. “By taking steps to address these long-standing problems, Congress will provide a boost to economic growth, innovation and job creation.”