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Jeff Meli Jonathan Millar

Episode 34

Jeff Meli in conversation with Jonathan Millar

Is the US infrastructure bill worth its high price tag?

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Following on the heels of nearly $5.0 trillion in COVID relief stimulus, the US administration is now proposing to spend another $2.3 trillion on infrastructure – a staggering amount by any standard.

The infrastructure bill intends to focus on the long-term, laying the groundwork for a more robust and resilient recovery. Its critics, however, worry about the potential for inefficiency and waste, as well as inflation, and the drag on investment and wages created by higher corporate taxes.

In episode 34 of The Flip Side podcast series, Head of Research Jeff Meli and Senior US Economist Jonathan Millar debate whether an infrastructure bill of this magnitude is necessary, the merits of the proposed spending initiatives, and the economic up- and downsides it may present if enacted.

  • Jeff Meli: Welcome to The Flip Side. I'm Jeff Meli, the Head of Research at Barclays and I'm joined today by Jonathan Millar, one of our senior U.S. economists. Thanks for joining me, Jonathan.

    Jonathan Millar: Thanks for having me on the podcast.

    Jeff Meli: Today we're going to discuss President Biden's infrastructure proposal. It is huge. With total outlays of nearly $2.3 trillion spread out over about eight years.

    It's funded through an increase in the corporate income tax rate, raising it from 21 percent to 28 percent. And by some other corporate tax provisions that are designed to limit revenue losses associated with overseas profit shifting.

    Jonathan Millar: Yes, as you'd expect from such a huge bill, it's already generating a fair amount of controversy, both on the spending side and the tax side. And it will likely remain in the headlines in the coming months. And though it's far from perfect, my position is that we need this bill.

    The proposal identifies a number of key initiatives that can help both to build upon the steady increases in labor force participation that help sustain the last recovery and to reinvigorate productivity growth. I think it's worth the high price tag as we look to unlock a more robust, inclusive and resilient recovery.

    Jeff Meli: Well, Jonathan, I disagree. Having gone through the proposal, I think there is a small core of initiatives that would be helpful in principle, but they're going to face important execution issues.

    I think the rest of the bill is wasteful. It generally defaults to increase spending as a solution to complex problems, when cheaper and more efficient alternatives seem to me to be available. And whatever benefit we do see needs to be offset against the distortions the economy will experience from higher corporate taxes.

    Before we really get into the specifics, I think we have to review what's actually in the proposal. It's such a monolith that we can't go through it line by line - that demonstrates just how hard it is to spend $2.3 trillion. But we can put the initiatives under three broad headings. The first heading, which is about $900 billion, is plain old infrastructure spending.

    It's things like the transportation system, electricity, water, broadband. This portion is about restoring and updating America's infrastructure and making it more resilient.

    Jonathan Millar: Yes, and that part has been simmering in policy circles for a long time and seems to have a fair amount of bipartisan support. Now, the other two components are more controversial. The second heading, which amounts to about $900 billion, is less about infrastructure and more about greening the economy and making it more inclusive.

    That is ensuring that a broader array of people experience the benefits of growth. This includes initiatives intended to address longer term problems, such as the lack of affordable housing in key metro areas, developing the workforce, caring for children and the elderly, and widening the use of electric vehicles.

    Jeff Meli: Now the final category, which is about $400 billion, is more of a grab bag of other policy priorities that includes measures to improve technological innovation by directing grants to research and development, has some more strategic measures to support domestic manufacturing, like subsidies to producers of semiconductors and to producers of PPE, which would make the U.S. more resilient if we see another pandemic.

    Jonathan Millar: Let me say, first, Jeff, that to my eye, at least, this bill seems to be structured pretty well, particularly given how we see U.S. activity playing out over the next few years. Now, to be clear, this $2.3 trillion would come on the heels of nearly $5 trillion of cumulative stimulus from the three COVID relief bills.

    Now, any way you slice it, that's a lot of money. But what sets this one apart is that it focuses on the longer term. It lays the groundwork for a more robust and resilient recovery, rather than providing stimulus per se. Since the outlays are spread over eight years or so, we think that the stimulative effect would be limited to about a percentage point increase in the level of GDP.

    And these outlays wouldn't really begin to ramp up until next year, around the time when the current wave of short run stimulus and pent-up demand from excess household savings is projected to fade. We don't think that risks of sustained high inflation were that substantial, even without this proposal, and we don't think it will be enough to push us over the edge.

    Jeff Meli: Well, Jonathan, I was happy to see that there's no need to identify shovel ready projects built into this bill. I don't think those projects really exist. And I think the reliance on them has led to waste in the past.

    But I'm much less convinced than you are on the timing. Between the massive stimulus bill that we just passed and the extraordinary excess savings that households have built up over the pandemic, which you and your team have written about, I'm worried that we're heading into the mother of all demand surges.

    Interest rates have already risen. And with all this government and household spending about to come, interest rates could go higher still. So, the borrowing environment in the next few years could be a lot less favorable than it appears to be today.

    Jonathan Millar: Well, I think you're overstating the inflationary risks. Folks have called for inflation for literally years, and it hasn't come. I think the market consensus is right.

    The most likely scenario is that PCE price inflation spikes in the next few quarters before settling back below the Fed’s 2 percent target. You say rates have risen, but I say they're still near historical lows.

    That's a green light from bond markets for the government to borrow money to finance productive projects.

    Jeff Meli: I also think we simply don't know if we even need all this extra spending until we see how the post pandemic economy evolves.

    Jonathan Millar: I disagree there too. I don't think there's any question we need this spending. We're coming off of a recovery in which economic growth was relatively modest, in large measure because of slow productivity growth. In my view, poor public infrastructure played a big role in that. And I think that most policymakers would agree with me.

    The fact is, since the global financial crisis, the government capital stock has grown at its slowest rates by far since the 1950s.

    Jeff Meli: Jonathan, the other broad-brush disagreement I have with this bill is with the funding, it's funded from raising corporate taxes. Now, whatever the benefits of the spending, which we're going to debate in a few minutes, we actually need to be focused on the net effect of a bill like this.

    After accounting for the drag from higher corporate taxes, I think that drag is going to show up in the form of lower corporate investment and in lower wages.

    Jonathan Millar: Well, Jeff, I don't think potential distortions are that worrying. First, businesses are going to benefit from better infrastructure.

    Second, I don't believe that higher corporate taxes have big effects on investment. As we argued back when the Tax Cuts and Jobs Act was being formulated back in 2017, the tax system is already designed to limit distortions to decisions about investment and hiring since businesses deduct wage expenses, and depreciation allowances before calculating taxable income.

    And I think our argument was borne out pretty well by the experience following the act, as we didn't see meaningful changes in the trajectory of business investment or hiring in 2018 and 2019. So by and large, we think that the windfall from the tax cut simply went to shareholders.

    Jeff Meli: Jonathan, I'm really surprised to hear you say that. I would have said that 2018 and 2019 was probably the greatest labor market the U.S. has had in decades, maybe even ever.

    Participation rates rose with really notable gains among some historically disadvantaged groups like minorities. And that happened after lots of economists thought that the economy had to literally run out of people to hire. On top of that, we finally saw some wage growth at the bottom of the income ladder.

    Jonathan Millar: Well, I totally agree with you that the steady rise in participation in years leading into the pandemic was a key development. But I'm not so sure we should attribute that to lower corporate income taxes.

    Our U.S. team did some research in last year's Equity Guilt Study, which suggested that a good bit of the increase in labor force participation was due to the Affordable Care Act. And if that's true, then it's a good example of how well-designed inclusive growth profit policies might spur growth by broadening the workforce.

    Jeff Meli: Well, we could probably debate that point for hours. In fact, we talked about corporate taxes in episode six of The Flip Side back when the tax cut for corporates was initially passed. But I still don't understand why corporate taxes, whether they're ultimately paid by shareholders or by workers or both, should shoulder the entire cost of this bill.

    Jonathan Millar: Well, the administration is certainly gambling that voters will see this as fair. Let me just say that even though I'm not too worried that higher corporate taxes will restrain growth, I tend to agree with your last point.

    If I were designing the bill, I would shift bunch of this burden to activities that use infrastructure such as an increase in the federal fuel tax, which goes to the Highway Trust Fund, user fees for airports, and things like that. From a pure economics perspective, that would be more efficient, helping to overcome problems with free riders and overuse of public goods.

    So anyway, Jeff, since we both kind of agree that the funding plan is less than ideal as it stands, let's kind of shove that aside and take – talk a bit about the merits of this major spending initiatives. At the core of those initiatives is $600 billion of new spending for roads, bridges, airports and ports. Now, can you honestly claim that this investment in transportation infrastructure would not benefit the U.S.?

    Jeff Meli: No, I do agree in principle that targeted spending on that type of transportation infrastructure would be a very good public investment.

    I think it's pretty clear that much of the infrastructure in our major cities is crumbling, and that a major overhaul would pay substantial dividends in terms of future growth. All you have to do is take one ride on the Brooklyn-Queens Expressway and you can see that many of our roads and bridges need some serious repair.

    But while I agree in principle, I think that there are some major reasons to think that this bill will come up short. And the biggest one is the political realities. That is, even though the spending is most sorely needed in a few of the oldest and most productive cities, getting the bill through Congress requires spreading a lot of the money around on less worthy projects elsewhere.

    Jonathan Millar: OK, I'll give you that, there will be some slippage in that direction. But one of the best aspects of that – of the bill is that it includes mechanisms to allocate funding to the most worthy projects, rather than earmark expenditures on pet projects.

    Jeff Meli: OK, but the waste is more meaningful than just the bridges and roads bit. Now, for example, take $80 billion directed at passenger railings.

    Now historically, Amtrak has enough difficulty turning a profit without having to expand its coverage to markets outside of the Northeast Corridor. And another 175 billion of the of the transportation funding is allocated to electric vehicles infrastructure, like creating a network of charging stations.

    And some of the calculations I've seen suggests that this would amount to a subsidy of 25 percent of the cost of every battery electric vehicle or BEV in the United States, after assuming a massive growth in the BEV share. Look, I can see why government should be responsible for building and maintaining our bridges and roads but why is government responsible for building charging stations?

    Jonathan Millar: Well, if we allow enough time to pass, I'm sure you're right, that the private sector would eventually develop this network. But if a faster transition to BEVs will generate huge environmental gains over the longer term that markets don't adequately take into account, it makes sense for the government to fast forward the transition.

    And, Jeff, let me remind you that the total spending from the two initiatives you just highlighted is on the order of the amount that the U.S. government allocated back in 1956, to construct the Interstate Highway System. At that time, I'm sure that this investment seemed like it could be a waste. But today, (this) strikes me as a ridiculous bargain.

    Jeff Meli: Well, the problem, Jonathan, is that this bill is filled with such bets. Now you pointing to a specific example, where a big government spending project paid off, is a far cry from saying that every big project has the same great effect.

    Jonathan Millar: Yes, and I guess that's a fair point. And I'm kind of stacking the deck against you in a way. But you know, at the end of the day, I have a pretty optimistic view about the government's ability to mobilize resources to address big challenges.

    This bill does – it does a good job of identifying many of the biggest structural challenges facing our society and would set us on a path toward solving them.

    Jeff Meli: Well, I do think you are accurately representing the ethos that underlies this bill and I think, in general, the thinking of progressives about the role of government. And I generally agree that the challenges identified in this bill are real issues that need to be solved.

    My critique is that the bill presents the same solution to each of them, a massive increase in government spending. Is that really the only solution that we can think of?

    Jonathan Millar: Well, I do think that well targeted spending can be very effective. One great example is research and innovation, which actually receives a lot of attention in this bill in various forms. You can make a strong argument that the Federal Government has played a key role in enabling some of the most transformative research over the past few decades.

    This includes many innovations that derive from the space program of the 1960s, such as solar cells, wireless technology, laptop computers, CAT scans, MRIs, to name just a few. The defense program also has a history of enabling big innovations, including funding many of the technologies that now underlie the internet and GPS.

    Jeff Meli: Well, those are great examples, Jonathan, and great technologies that we've made good use of, but there are also cases where the country was mobilized to address some very specific challenges, like putting a man on the moon or defending itself against a nuclear superpower.

    It's not really the approach of, hey, let's just throw some money at research and good stuff will follow. I don't think it's all that easy to replicate those historical examples.

    Jonathan Millar: Now, I need to push back against that, Jeff. I think there are ways that the government can direct money at general research and have good stuff follow. In particular, grants made through the National Science Foundation or the NSF have a long history of success. Playing a key role in the development of the search technology behind Google, the creation of smartphones, and even DNA research.

    These are great examples of the government providing funding for general research that at least initially does not have obvious private sector applications, and then the private sector finding ways to profit from the technology. Indeed, I think the U.S. is kind of in a unique position to fund this type of research given its unparalleled network of researches – researchers and the universities and the economies of scale afforded by its large tax base.

    Jeff Meli: My critique extends, as well, to the inclusive growth initiatives that you touched on earlier. Two of the biggest issues identified are the lack of affordable housing and caring for the aging population.

    Now, in both of those cases, throwing money at the problem just doesn't resonate. Now let's take as an example, the bill has $213 billion in funding for affordable housing. Now, I agree that making housing in productive cities more affordable is a worthy goal.

    But this strikes me as the wrong solution. High housing costs have a lot more to do with local zoning, which restricts density and raises housing prices. Wouldn't it be far better to just change zoning regulations? And for the record, that doesn't cost anything.

    Jonathan Millar: OK. Well, I actually agree with you that zoning laws are probably the most important driver of affordable housing. But zoning is not within the scope of the Federal Government.

    Given that, the most realistic tool for the government to address this problem is through spending, persuading major cities to adjust zoning would be better, but it's unrealistic.

    Jeff Meli: I'm not sure how unrealistic it is. The potential funding from this bill gives the Federal Government a pretty big stick to wield to get local governments to change their zoning, if this bill was to pass.

    But anyway, here's another example of potentially wasteful spending, high speed broadband. The proposal allocates $100 billion to bring broadband to all parts of the country, rural and urban.

    Jonathan Millar: Hold on, Jeff, come on, you can't be serious. Are you suggesting in the year 2021 that it would be a waste of money to improve broadband access?

    Jeff Meli: What I'd say is that we want the most productive workers in our country to move to highly productive urban centers. Actually, that's one of the reasons why high housing costs are such a problem, because they interfere with this agglomeration of talent. People find it's too expensive in these productive cities, and they can't live there.

    I don't think we actually want to make it easier for productive workers to just sort of get by in more dispersed settings, then we risk losing the productive benefits that come from all that agglomeration. If you extend broadband to more remote areas that could be the result.

    Jonathan Millar: Well, there is some truth to what you're saying. And I think this can be said more generally, people are only willing to pay higher housing costs that comes with higher wages or amenities that they find valuable.

    Indeed, I may be willing to live in a low-cost area with poor broadband access, because I just don't have use for the internet. And once I made that decision, it would be wasteful for the government to turn around and pay for transmission lines to my house. But I think the sorting argument you're making here overlooked some important considerations.

    For instance, if I have children, they didn't decide to live in an area with poor broadband access. And they may be put at a disadvantage compared to children in areas with good access.

    Another point I'd make is that my decision might prove costly if the situation changes. Indeed, if I could find myself in something like say, a pandemic, when internet access becomes the difference between working and not working, could become a problem. And society pays a cost for that lack of resilience.

    So why not just identify broadband as an essential service like a telephone and move on?

    Jeff Meli: Well, I think your pandemic point is a fair one. But let me give you another example. The proposed bill includes $400 billion of spending for community and home-based care for the elderly, it's actually nearly a fifth of the overall cost of the bill.

    Now, again, the problem of caring for the aging population is a serious long-term challenge that our society is going to have to face. I don't see how jacking up public spending is the real solution. And if the funding comes through Medicaid, that raises all sorts of questions like, do people need to exhaust all their savings to qualify?

    I don't think we've really explored this issue enough to justify throwing $400 billion at it right now. And on top of that, I don't see how we could possibly classify this as infrastructure.

    Jonathan Millar: Well, you raised some good questions there. And this is one area where I struggle a bit because we don't have a lot of specifics about the policy.

    I do agree that this does seem like a lot of money for one initiative, and that it might be better thought of as entitlement spending rather than infrastructure. But let me also say that it might be regarded as more infrastructure in one sense, like childcare, providing care for the elderly can help free up family caregivers to enter the workforce. If this unlocked some more productive allocation of workers, then there might be some benefits for productivity.

    Jeff Meli: Well, Jonathan, I take your point that the details of the proposal are still evolving. And given the realities of the split Senate, I wouldn't be surprised to see considerable changes as Congress and the broader public debate the proposal.

    I'm going to be watching particularly for analyses that help justify some of the expensive initiatives in this proposal that have been sort of thrown in under the heading of infrastructure by looking at the costs and benefits associated with them. In any case, I'm sure that you and our research team will have plenty to say about the proposal as it evolves.

    In the meantime, clients can refer to Barclays Live for some of our previous work that we've done on the effects of the 2017 Tax Cuts and Jobs Act, our research on reinvigorating U.S. labor force participation in the 2020 Equity Guilt Study, and our piece on U.S. excess household savings framing the debate about the likely spending patterns in the post pandemic economy.

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About the analysts

Jeff Meli is Head of Research within the Investment Bank at Barclays. Jeff joined Barclays in 2005 as Head of US Credit Strategy Research. He later became Head of Credit Research. He was most recently Co-Head of FICC Research and Co-Head of Research before being named Head of Research globally. Previously, he worked at Deutsche Bank and JP Morgan, with a focus on structured credit. Jeff has a PhD in Finance from the University of Chicago and an AB in Mathematics from Princeton.

Jonathan Millar is Senior US Economist at Barclays in New York. He has expertise in monetary policy, productivity, business investment and the industrial sector. Prior to joining Barclays, Jonathan was a Principal Economist at the Board of Governors of the Federal Reserve in Washington, DC. He also spent two years in Paris as an economist with the Organisation for Economic Development. Prior to these roles, Jonathan taught economics at the University of Michigan and had positions at the Bank of Canada, at the IMF, and as a specialist in energy derivatives at DTE Energy Trading.

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