A bipartisan deal on astimulus package has been reached between
House Speaker Nancy Pelosi (D-CA) and House Minority Leader
John Boehner (R-Ohio). The package reportedly includes tax rebates
for wage earners and tax cuts for businesses.[1] Certain elements
would boost the economy both in the short- and long-term, but other
elements would do little and should not make the final cut in any
stimulus package.
As the agreement is being reported by the media, its positive
aspects are tax cuts to boost business investment and a rejection
of new government spending. The negative aspects are refundable
rebates that function more as handouts thanstimulus, no new tax
cuts that could be returned as a rebate, and an expanded government
role in the housing market.
The Good
The best part of the agreement is tax cuts for businesses.
"Bonus depreciation," which allows companies to rapidly deduct
qualified investment from their tax liability, makes new investment
opportunities more profitable and attractive. This provision would
increase business investment, which would create jobs and
strengthen the economy.
An even better approach would have been to extend the pro-growth
elements of the 2003 tax cuts, which reduced taxation of capital
gains and dividends. Those tax cuts and the bonus depreciation
helped spark the economy in the latter part of 2003. Since
investment is forward-looking, many businesses are in the process
of making investment decisions for 2011 and beyond. Permanent
reductions in the cost of capital would help the economy by
eliminating the uncertainty that businesses face when making
investment considerations.
Business investment was flat in the second quarter of 2003 but
grew by 3 percent and 5.1 percent, respectively, in the third and
fourth quarters after passage of the 2003 tax cuts. The increase in
business investment reversed the trend of the earlier three
quarters, when investment declined by 6.5 percent, 3.8 percent, and
then grew at 0 percent, respectively. In the quarter immediately
following the 2003 tax cuts, the economy began to add jobs, and job
growth has continued every month since.
Thestimulus package appears to have rejected some of the
additional spending that many politicians wanted. A number of new
spending proposals, from bridges to renewable energy, were
described as stimulative. Because the government is running a
deficit, funds for new spending must be borrowed from domestic
savers (which reduces investment spending) or from foreigners
(which reduces net exports). There is little reason to trust
politicians to make the right public investments. It is better to
reduce tax rates and let businesses, families, and markets decide
on the most productive way to spend money.
Also, the newstimulus package does not extend unemployment
insurance (UI) benefits. Extending unemployment benefits does not
stimulate the economy as some politicians assume. Instead, it
reduces the incentive of workers to look for a new job. Studies are
almost unanimous in concluding that extending UI leads to workers
staying unemployed for longer periods of time. UI also
encourages employers to wait longer to hire workers after temporary
layoffs. Also, extending UI does not increase consumption as
expected. When workers get additional benefits, they do not spend
their personal savings, and spousal earnings fall. Only 50 cents of
each dollar spent on UI funds new consumption. The UI system is
designed to cushion the pain of losing a job, not to improve the
economy. Studies find that it has, at best, a modest effect on
economic growth.
Like most legislation, thestimulus bill is likely to
become increasingly expensive as it makes its way through Congress.
Lawmakers sensing a "Christmas tree" bill are likely to each demand
their own spending ornaments in exchange for their votes. As
sound economic policies take a backseat to political expediency,
taxpayers will be left funding a massive increase in government
(and future taxes) that does little to stimulate economic growth.
To avoid that scenario, responsible lawmakers must draw a line in
the sand and reject any new spending initiatives from being added
on the House and Senate floors.
The Bad
One of the key components of the package is a targeted rebate
that is refundable against payroll taxes. Proponents of rebates
believe that people would quickly spend their rebates, thus
providing a short-term boost to consumption and the economy.
However, traditional economic theory holds that rebates have
limited impact unless recipients believe their permanent income
will increase. The rebate would also do little to change incentives
to work or invest; thus, it would not be effective in boosting
long-term economic growth. Tax rebates and similar cash transfers
don't stimulate the economy. The federal government cannot just
wish new purchasing power into existence. The government must
borrow the funds for the rebates, which means either less money
available for investment or an increase in the trade
deficit.
In the fall of 2001, the government attempted a rebate in the
form of an advance payment of the 2001 tax cut. A survey of rebate
recipients found that less than a quarter of households planned to
spend their rebate.[2] Most respondents said they would use the
rebate to pay down their debt. A different study of the rebate
found that spending over the next year did increase by
approximately one-half to three-fourths of the rebate.[3] But it
is possible that this relatively high amount of consumption
occurred because the rebate was a pre-payment of a larger tax cut
that some taxpayers might have considered permanent.[4] Unlike
2001, the rebate in the newstimulus agreement is not attached to a
larger, long-lasting tax cut that could alter incentives to work or
save more. Individuals would likely see the rebate as a temporary
addition to income, in which case they would be more likely to save
it or pay down debt.
Supporters of rebates believe that low-income households are
more likely to spend their rebate. However, two recent studies of
the 2001 rebate and the 2003 rebate challenge that notion. A Joint
Tax Committee report states that the 2001 study "found no evidence
that low income individuals were more likely to spend their
rebate."[5] More surprisingly, a Federal Reserve Board
study found that households with an income of more than $100,000
were more likely than households with less than $30,000 to spend
the 2003 child tax credit rebate or to spend more of the reduced
tax withholdings in a paycheck.[6] In reality, the rebate
appears to be little more than a targeted government handout for
low-income Americans, dressed up as a stimulus.
A more disturbing aspect of the package is a provision that will
allow the federal government to get even deeper into the
residential finance market by being able to acquire more mortgages.
Fannie Mae and Freddie Mac-companies that are given extensive,
special privileges by the federal government-would be allowed to
purchase more expensive home mortgages valued at up to $725,000,
which is well above the median home price. The government should be
reducing its role in the mortgage market instead of expanding it
and crowding out private companies.
Conclusion
Thestimulus package has one element that would contribute to
both short-termstimulus and long-term economic growth: the
business tax cuts. Also, Representatives Pelosi and Boehner deserve
praise for resisting, thus far, the urge to load up the agreement
with all sorts of new spending programs. Such spending would
increase the deficit and would have little impact on economic
growth. However, the provision that allows government-sponsored
mortgage companies to buy more expensive houses is misguided.
Astimulus bill is not the place to expand government
interference in the economy, bail out banks that make bad loans, or
pile on unrelated new spending. Congressional leadership should
resist any attempts to do so. Instead, they should focus on
pro-growth policies. The bonus depreciation proposal is the
strongest part of the agreement and should be strengthened by
extending current tax rates on dividends and capital gains and
indexing capital gains. While a tax rebate may be inevitable at
this point, the public should recognize that this rebate is poorly
targeted and would not have a significant effect on the
economy.
Rea S. Hederman,
Jr., is Assistant Director and Senior Policy Analyst in the
Center for Data Analysis at The Heritage Foundation.