Produce a reliable income stream, not a short-term stimulus

The problem with having a short attention span is the assumption that everyone else must have one, too.  That’s the kind of thinking that goes into short-term stimulus plans, and the reason they fail.  As John Taylor, former Undersecretary of the Treasury, explains in his Wall Street Journal op-ed, the best stimulus comes from a reliable reduction in tax rates that allow for planning, not impulse shopping:

The argument in favor of these temporary rebate payments was that they would increase consumption, stimulate aggregate demand, and thereby get the economy growing again. What were the results? The chart nearby reveals the answer.

The upper line shows disposable personal income through September. Disposable personal income is what households have left after paying taxes and receiving transfers from the government. The big blip is due to the rebate payments in May through July.

The lower line shows personal consumption expenditures by households. Observe that consumption shows no noticeable increase at the time of the rebate. Hence, by this simple measure, the rebate did little or nothing to stimulate consumption, overall aggregate demand, or the economy.

These results may seem surprising, but they are not. They correspond very closely to what basic economic theory tells us. According to the permanent-income theory of Milton Friedman, or the life-cycle theory of Franco Modigliani, temporary increases in income will not lead to significant increases in consumption. However, if increases are longer-term, as in the case of permanent tax cut, then consumption is increased, and by a significant amount.

Common sense?  Only to those who have to actually plan and live on budgets.  A $600 rebate check — which consists of nothing more than a one-time return of our own money — will not allow taxpayers to buy a new car or even a new appliance, because we can’t rely on that revenue stream.  We know that the check is a one-off, and we treat it like found money.  Most will pay bills, and some will put the money aside for security.  Even those who spend it won’t spend enough in consumption to make a difference in a large-scale economy such as ours — not with a one-time rebate.

In order to encourage consumption and thereby strengthen the economy, people need to know exactly where they stand month to month.  They need to know that any extra revenue will be reliable and plannable, not drop out of the sky once with no guarantee of return.  The car they couldn’t afford before that rebate will still be unafforable afterwards, and the investments they want to make will still be outside their reach.

Advocates point to the success of the 2001 tax rebates, but Taylor points out that they had another quality absent from this last round: permanence.  The 2001 rebates intended to apply the first round of Bush tax cuts as a retroactive measure, refunding the difference.  It allowed taxpayers to see how much more of their own money they would get to keep, and to plan new spending based on those consistent, reliable numbers.  Not only did the 2008 stimulus lack that, but most people expect their taxes to go up, not down, in the midst of this financial crisis.

The economic collapse we are experiencing is far too great to get stopped by a temporary gesture like a one-time tax rebate.  The only way to rebuild confidence and restart consumer spending is to restructure tax rates to encourage that by reducing the confiscation of their earnings in a predictable and plannable manner.  Unfortunately, the incoming Obama administration appears as fond of gimmickry as the Bush administration and the Democratic Congress has been over the last year.

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