Part of President-Elect Barack Obama’s plan for a stimulus package consists of mailing people rebate checks, similar to the ones mailed by the government earlier this year. But experience suggests that this is a poor way to stimulate economic growth.
John B. Taylor, a former Under Secretary of the Treasury for International Affairs and currently a senior fellow at the Hoover Institution and a professor of economics at Stanford University,
provides an analysis of the recent stimulus package in the Wall Street Journal. Taylor showed that while disposal income enjoyed a blip around June 2008 due to the stimulus rebate check, personal consumption expenditures did not enjoy any increase.
Temporary increases in income do not lead to permanent increases in consumption. People who receive temporary rebate checks realize that the operative word is “temporary” and will tend to either save the money or else pay off debt. They will certainly not buy big ticket items such as automobiles that require a long time to pay off, being uncertain about their future income and economic conditions.
So how does Obama provide a stimulus that will foster long term, economic growth? Taylor suggests something that may be heretical to the incoming Obama administration, but has tended to work when tried. While the theory behind issuing rebate checks is that stimulus should be “temporary, targeted and timely,” Taylor suggests that a stimulus should be “permanent, pervasive and predictable.” He suggests that a permanent stimulus package should “focus on the “automatic stabilizers” (the tendency for tax revenues to decline in a recession and transfer payments such as unemployment compensation to increase in a recession), which are built into the tax-and-transfer system, and on more permanent fiscal changes that will positively affect the long-term growth of the economy.”
How to accomplish this? Taylor suggests the following:
“First, make a commitment, passed into law, to keep all income-tax rates were they are now, effectively making current tax rates permanent. This would be a significant stimulus to the economy, because tax-rate increases are now expected on a majority of small business income, capital gains income, and dividend income.
“Second, enact a worker’s tax credit equal to 6.2% of wages up to $8,000 as Mr. Obama proposed during the campaign — but make it permanent rather than a one-time check.
“Third, recognize explicitly that the “automatic stabilizers” are likely to be as large as 2.5% of GDP this fiscal year, that they will help stabilize the economy, and that they should be viewed as part of the overall fiscal package even if they do not require legislation.
“Fourth, construct a government spending plan that meets long-term objectives, puts the economy on a path to budget balance, and is expedited to the degree possible without causing waste and inefficiency.”
A good idea to add to John Taylor’s suggested program would be to also cut corporate, capital gains and dividend taxes to further stimulate the economy. A big spending program should be avoided because, as Taylor points out, it “does not address the causes of the weak economy, which has been pulled down by a housing slump, a financial crisis and a bout of high energy prices, and where expectations of future income and employment growth are low.”
History tells us that cutting taxes, especially when accompanied by cuts in government spending, tend to work best in stimulating the economy. This was true in the case of the Kennedy tax cuts in the early sixties, the Reagan tax cuts in the early eighties, Gingrich cuts on capital gains taxes in the 1990s, and the Bush tax cuts in the current decade. Barack Obama, on the other hand, seems bent on embarking on yet another Keynsian experiment, such as was attempted by FDR in the 1930s. The FDR public works program failed to end the Great Depression. Obama’s similar infrastructure stimulus plan will likely fail as well.
Source: Why Permanent Tax Cuts Are the Best Stimulus, John B. Taylor, Wall Street Journal, November 25th, 2008