Monday, February 4, 2008

Please stop with this silly stimulus package

In a previous post, I already detailed how (possibly) little impact on consumption a stimulus package may have. Economists tend to agree that the stimulus package is not the best idea out there, to give you an understatement, but politicians do not seem to listen to economists. That is their prerogative, but let me add a few arguments that they should be listening to, including some repeats.

  1. A fiscal stimulus package has only a limited impact if people believe that tax will go back up, and the current situation is certain fertile for such beliefs
  2. Imports are likely to absorb a portion of the (small) increase in consumption. China will be grateful.
  3. Is the situation really so dire? Most indicators are still robust. There is no reason to panic. Obviously, if journalists react to a tiny 17,000 unit reduction in payrolls by claiming "Employment drops in a pink slip blizzard," it does not help.
  4. Never have politicians managed to spend $150,000,000,000 with so little scrutiny, discussion and consultation of experts. Well, maybe with the Iraq war, but that is a different story.
  5. Lack of consumption is certainly not the problem in the US, it is rather the lack of savings, with currently a negative aggregate savings rate. One should penalize consumption, not encourage it!


T-Bone said...

I disagree with your first bullet, that people will save if they expect the tax rebate to be temporary. That seems to depend super-rational individuals to make that economic model work.

Real people will treat the rebate the same way they treat a tax refund when they've overpaid on their amount withheld from their paycheck each month. Even if tax rebate were made into a permanent tax cut, the vast majority of people wouldn't know the difference.

I'll agree with points 2 through 4. However, on the 5th point that consumption is the problem... well I think yes and no.

On an individual level, people should be trying to live within their means to avoid financial problems. But for people who are well-off financially, not threatened by financial problems, there is no need for them to save. I'd say it would help economic growth for them to spend, and if we could encourage them to spend, it'd be a good thing.

On a macro level, spending/demand is what drives economic growth and creates investment opportunity. And that creates jobs, jobs which add more people to payrolls so those people can demand more goods and services themselves. And higher employment tightens labor supply, pressuring wages upward. Higher wages creates a permanent increase in demand/growth, rather than the temporary effect created as people dig into savings.

So yeah, let's try to encourage financially insecure people to live within their means and save to reduce risk. But it doesn't mean we can't prime to pump to put that excess labor supply to use through whatever means (spending, low income tax cuts, covering expenses such as health care). And I say this not as a suggestion for avoiding a recession, but as a general direction to pursue anytime. It just that it's a little more urgent when job growth is lacking.

I'd personally say spending would be the best choice. For example, my state has a real infrastructure problem with bridges deteriorating all over the state to the point of being unsafe. What is a better time than now to create jobs (and incomes) by replacing the bridges.

Or another suggestion I had... The cooling house construction industry could maybe be less sudden though a tax credit for installing solar panels for heating water and general electrical needs, or for fixing inefficiencies such as lack of insulation.

Sorry for the lengthy comment.

Vilfredo said...

T-Bone, point 1 refer to the previous post on Ricardian Equivalence. I am convinced it applies here and it is obvious taxes will need to go back up to finance this and other tax cuts.

T-Bone said...

Yeah, that post says:

"Indeed, households realize after a tax cut that they will have to pay to pay higher taxes in the future, and thus save the tax cut for the future tax increase. They do so by buying the very bonds the government is issuing to finance the tax cut.

Now, this very strong theorem holds only under some stringent conditions, basically that welfare theorems hold (no distortionary taxation, complete financial markets, no monetary non-neutralities, etc.). These conditions are unlikely to hold in reality, so the empirical question is whether a tax cut does increase consumption or not (and the not includes a decrease)."

So that post says it unrealistic that people (at least middle or lower income people) would buy bonds with their temporary tax rebate. There wouldn't be a difference if the tax cuts were permanent or not.

So the post suggests that a more realistic thing to look for is whether the rebates increase consumption. Well, the lower the income of the people that the rebates apply to, the more consumption would increase (marginal propensity to consume).

But I guess you're saying it'll mean that in the future, consumption would need to be lowered due to tax increases to recoup the money lost on the rebates.

Sure, but I'd say we should be paying for the tax rebates (or spending, or permanent tax changes) with something like a capital gains tax, which will have very little effect on consumption.

Anonymous said...

Nobody seems to notice that this is not a tax rebate but rather an advance on the tax refund of 2009. This is false representation by the government for two reasons: 1) not giving it the proper name; 2) luring people into spending it without alerting them to the fact that this is not a permanent gift, it will need to be returned in April 2009. Could this put people in personal bankruptcy?