The Wall Street Journal-20080111-The Right -Stimulus-
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The Right 'Stimulus'
We've been saying for some time that the economy could use another tax cut, so perhaps we should be pleased that Washington is suddenly talking about a fiscal "stimulus." The challenge now is getting politicians to distinguish between policies that actually "stimulate" and the equivalent of dropping hundred dollar bills from helicopters.
Not that this recent talk isn't progress of a sort. At least the politicians are beginning to understand that the Federal Reserve can't flip its easy-money switch and immediately end the credit crunch, forestall home foreclosures, and leap tall buildings at a single bound. Chairman Ben Bernanke implied in a speech yesterday that big interest-rate cuts may be coming, and bond markets immediately sold off. Currency traders may also have their say, especially if the European Central Bank decides to tighten. Monetary policy can't do everything, and it becomes dangerous if it tries to do too much.
Which brings us to the Beltway's new fiscal stimulus debate, such as it is. The White House is leaking trial balloons about its proposals, while the Democratic intelligentsia is already promoting its ideas. So far, nothing we've seen would stimulate much beyond campaign rhetoric.
Former Treasury Secretary Larry Summers is leading the charge for the Democrats, pushing what he calls a "timely, targeted and temporary" tax rebate of $250 per tax filer, and $500 per couple. The White House is floating its own rebate of $500 or so for families with taxable income of less than $100,000 a year. Mr. Summers says his plan would put money in the pockets of "those who would go out and spend it."
Or not. Mr. Summers is pushing a version of single-entry Keynesian bookkeeping, which holds that if the government hands out cash to workers they will spend it and "stimulate" the economy. But the money the government would thus "inject" in the economy has to come from somewhere. That is, it has to be raised in taxes or borrowed, which means it is taken from someone else in the private sector. Under more accurate double-entry bookkeeping, this stimulus is likely to be minuscule.
As for "spending it," we tried this a few years back and it didn't work very well. As part of the grease to pass his 2001 tax cuts, President Bush agreed to a $300 rebate ($600 per couple) urged on him by Senate Democrats. As the nearby chart shows, the economic gain was short-lived to the extent there was any at all. Several economists have also done research suggesting that the bulk of that rebate was in fact saved, not spent. That's virtuous, but it isn't a "stimulus."
More encouraging is a White House leak to allow so-called "bonus depreciation" for businesses for 2008. This would increase business cash flows, and a version of this proposal seemed to help in 2003- 2004. The problem arises if such a tax cut is temporary. This would give businesses an incentive to speed up spending this year, but in part by stealing it from next year.
A real fiscal stimulus is one that immediately and permanently changes the incentives for individuals and business to work, invest and take risks. That's the comparative lesson of the two Bush tax cuts, as the chart again illuminates. The 2001 tax cuts were useful as a way of getting marginal income-tax rates down eventually. But in addition to the rebate folly, the rate cuts were phased-in and thus gave everyone an incentive to postpone investment. The stimulus came in 2003 when the marginal rate cuts were accelerated and capital gains and dividend rates were slashed immediately.
The irony is that these are precisely the lower tax rates that Mr. Summers and Democratic politicians want to raise. No brand of Keynesianism we've studied says you stimulate an economy by raising taxes. This promise to repeal the Bush tax cuts is already having an impact on investors as they consider what the tax on capital and business will be like next year. If Democrats really wanted to spare a President Obama from a first-year economic problem, they'd promise to make the 2003 tax cuts permanent.
As for a stimulus now, one that works would be marginal (at the next dollar of income), immediate and permanent. A proposal to bring the U.S. corporate rate into line with the rest of the world would help, and even better would be an across the board cut in income taxes to 30% from 35%. That would be real recession insurance.
