Monday, January 28, 2008

Stimulus Roundup

I haven't written much about the stimulus plan weaving its way through Congress because I think it is mostly irrelevant. It isn't big enough to have much impact either way. However, the economic logic of the plan is so flawed, it is too big a target to pass up.

The plan currently before Congress is a bipartisan effort to buy votes in an election year. The first clue that it is a bad plan is the bipartisan nature of it. I can't think of anything that Democrats and Republicans have ever agreed on that turned out to be a good idea.

The current plan takes the form of a tax rebate and some accelerated depreciation for corporations. Tax rebates have been tried before and despite the fact that they haven't worked in the past, politicans keep trying. I think that is the definition of insanity; doing the same thing over and over expecting a different result. The fact is that rebates do not change peoples spending because they don't change their long term income. Rebates are more likely to be saved than spent so any stimulus will likely be muted. Besides, the idea that politicians can take money from one group of citizens and give it to another group of citizens and "stimulate" the economy is stupid on its face. The government will have to either borrow (likely) the money for the rebates or raise tax rates and neither of those options is stimulative.

The normally sane Caroline Baum at has a suggestion that would ensure that the rebate gets spent:

For starters, don't send folks a check in the mail, even if the Internal Revenue Service can find time in its busy tax- return processing schedule to dole out money with one hand as it's confiscating a portion of our income with the other.

Instead, send households a coupon for the desired amount, to be used for the purchase of domestically produced goods and services. (No ``Made in China,'' which doesn't help the U.S. economy.) The coupon will carry an expiration date, which could be staggered depending on when the government wants the spending to take place. Maybe a little this quarter, a little the next.

I'm not sure if she is kidding or not but it seems she is serious. The problem with our economy is too little saving and investment and too much spending (and too much debt to fund it). So by all means, let's make sure that people don't even have a chance to save or invest this little windfall. That'll make things better.

Bob McTeer, former Fed governor, has a better grasp of things:

With monetary policy not getting the job done, many are calling for fiscal stimulus - more government spending or lower taxes. But while fiscal measures to stimulate the economy are tempting, it's a temptation that should be resisted for several reasons.

First, is timing. By the time it is formulated, passed by Congress, and implemented, the fiscal measure may be the opposite of what is then needed. Second, fiscal policy doesn't work without the appropriate accompanying monetary policy, but if monetary policy is appropriate - meaning more aggressive - then it is probably sufficient without a fiscal component. Fiscal ease, or an increased budget deficit, without appropriate monetary expansion puts upward pressure on interest rates and crowds out private-sector borrowing and spending. We'd just end up substituting government spending for private-sector spending, not a good recipe for growth and prosperity.

Politicians say we should put money in the hands of middle-and low-income people because they are more likely to spend it that those with higher incomes. More redistribution may or may not be desirable for social reasons, but the idea rich folks don't spend their money is ridiculous. Their saving goes into a financial intermediary or financial instruments that provide funds for investment. Taking it to the bank rather than the store is just the first step. The rich generally don't put their money in mattresses.

Old-fashioned stimulus through more net government spending is a poor substitute for supply-side fiscal measures that increase incentives to work and produce. The most important and most effective fiscal measures for now and for the future would be to remove the threat of higher marginal tax rates on both labor and capital that would result from the expiration of the Bush tax-rate cuts. Those reductions should be made permanent as soon as possible, and even augmented, especially the taxes on capital gains and dividends.

Lower tax rates on capital is about as close to a free lunch as it gets. The lower rates, by stimulating more activity, almost always generate more tax revenue. Close behind making the Bush tax cuts permanent in importance would be to reduce significantly the corporate income tax, which is currently internationally noncompetitive, and eliminate the death tax, which dilutes and distorts incentives of small businesses to maximize output and employment. Tax credits for new investment, or the expensing of investment rather than depreciating it, should also be considered. For the longer run, of course, fundamental tax reform is needed - either a low flat income tax or a tax on consumption rather than income.

A real stimulus plan should concentrate on long term problems and long term solutions. Tax rates are scheduled to rise in 2010 and that will start to affect economic decision making soon if it hasn't already. Raising taxes during a recession is surely a bad idea so if things are as dire as some think (and I don't fall in that category), then we should remove the fear of higher taxes now. Another idea would be to lower the corporate tax rate. Our rate is already near the highest in the developed world and if companies are the source of new jobs, lowering their tax rate would do more for hiring than any tax rebate. Besides, cutting corporate taxes is almost the same as cutting individual tax rates. Corporations don't pay taxes, people do. Corporations merely pass them along.

I do not think the current economic slowdown will turn into a recession but if it does the current stimulus plan will do nothing to prevent it. Since the public seems to think we need stimulus why not do something that will have an effect?

I'm not the only nut out here who thinks the economy is okay. Brian Wesbury has a good editorial at the WSJ today:

It is hard to imagine any time in history when such rampant pessimism about the economy has existed with so little evidence of serious trouble.

A year ago, most economic data looked much worse than they do today. Industrial production fell 1.1% during the six months ending February 2007, while new orders for durable goods fell 3.9% at an annual rate during the six months ending in November 2006. Real GDP grew just 0.6% in the first quarter of 2007 and retail sales fell in January and again in April. But the economy came back and roared in the middle of the year -- real GDP expanded 4.4% at an annual rate between April and September.

With housing so weak, the recent softness in production and durable goods orders is understandable. But housing is now a small share of GDP (4.5%). And it has fallen so much already that it is highly unlikely to drive the economy into recession all by itself. Exports are 12% of the economy, and are growing at a 13.6% rate. The boom in exports is overwhelming the loss from housing.

Personal income is up 6.1% during the year ending in November, while small-business income accelerated in October and November, during the height of the credit crisis. In fact, after subtracting income taxes, rent, mortgages, car leases and loans, debt service on credit cards and property taxes, incomes rose 3.9% faster than inflation in the year through September. Commercial paper issuance is rising again, as are mortgage applications.

Wesbury is a good economist; read the whole thing.

Greg Mankiw is also skeptical about the stimulus package:

I am personally skeptical that the economic weakness is sufficient at this point to justify such a package. Yesterday CBO came out with its forecast, including "growth for the year as a whole of under 2 percent and an increase in the unemployment rate to an average of 5.1 percent." That is similar to the current predictions of some of the best private forecasters, who put near-term growth between 1 and 2 percent.

As are a number of other respected pundits:

Andrew Samwick
Steven Landsburg
Robert Samuelson
Russell Roberts
James Hamilton
James Cramer
Arnold Kling
Donald Boudreaux
Alan Reynolds
Bruce Bartlett
George Will

I hope this plan fails. It has no real stimulus and will only exacerbate our long term problems. I suspect the Fed has already done more than enough to avoid a recession (if one was even likely to begin with) and adding this $150 billion dud will accomplish nothing other than allow politicians to pat themselves on the back when the recession doesn't happen. And that is dangerous because people already have way too much faith in government.

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