Thursday, January 24, 2008

Fiscal Graffiti

The administration and the House have agreed on a $150 billion "stimulus package" centered on tax rebates intended to increase aggregate demand. The effectiveness of such a policy depends, in part, on how it is distributed. According to the Congressional Budget Office:
Households are particularly likely to spend a greater share of a temporary reduction in taxes or additional transfer payments if they are credit constrained (that is, they have borrowed as much money as creditors will lend them). Given that these households would probably borrow additional money if given the opportunity, they are unlikely to save additional income. They are therefore likely to spend a greater proportion of a tax reduction or a transfer increase than other people who have access to credit. Lower-income households are more likely to be credit constrained and more likely to be among those with the highest propensity to spend. Therefore, policies aimed at lower-income households tend to have greater stimulative effects.
The initial proposal by the administration was (unsurprisingly) skewed more towards higher income taxpayers because it would only apply to households that pay income tax, and many low and moderate income families have no income tax liability (though they do pay the social security payroll tax). The Democrats negotiated for a package that would send checks to more low income households. The Washington Post reports:
Under the deal, nearly everyone earning a paycheck would receive at least $300 from the Internal Revenue Service. Workers who earned at least $3,000 last year -- but not enough to pay income taxes -- would be eligible for $300.

Overall, 117 million families would receive a rebate check, including 35 million with incomes too low to have qualified under the earlier Bush proposal. Those 35 million families would receive rebates totaling $28 billion.

Many will get more than the minimum $300: the payout is structured as a "rebate" of 10% of taxable income, with a maximum payout of $600 ($1200 for a married couple), plus $300 per child, and is phased out for people with incomes above $75,000 ($150,000 for married couples). There is also about $50 billion in additional tax deductions for business investments.

Unfortunately, the Democrats gave in on extending unemployment benefits and increasing food stamps, options that the CBO rated "large" for cost-effectiveness, "short" for lag time in impacting the economy and "small" for uncertainty of effects. If the downturn gets nasty, hopefully those provisions will be revisited (or maybe the Senate, which has yet to act, will put them in).

I'll take the deal as a glass half-full: the administration decided to refrain from using the issue to push extensions of the tax cuts currently scheduled to expire in 2011, the package is relatively clean and simple and will get checks into people's hands this spring or summer, and it is a minor miracle to get an agreement at all. Paul Krugman sees it as mostly empty:

[T]he stimulus bill will be a real disappointment. As I pointed out in an earlier post, economic theory — Milton Friedman’s theory! — suggests that if we want stimulus funds spent, they should go to people in temporary economic difficulty who are likely to be liquidity-constrained. But it appears that most of the measures that would do that — benefits to the unemployed, food stamps, aid to state and local governments — are being bargained away. Even the tax credit is apparently not fully refundable, so those who need it most, and are most likely to spend it, won’t get the full amount.

You can blame the Bush administration, whose hostility to helping those in need is now getting in the way of good economic policy. But I’m also disappointed with the Democratic leadership, for not standing up more forcefully.
Greg Mankiw believes the whole thing is dubious:
I am personally skeptical that the economic weakness is sufficient at this point to justify such a package...

In this environment, I would prefer to rely on monetary policy as the main source of macroeconomic stimulus. If there were a stronger case for a short-run demand-oriented fiscal stimulus, I would view the compromise package announced today as reasonable. But given where the economy is right now and the best forecasts of where it is heading, the fiscal package seems unnecessary as a short-run measure, while in the long run adding to the debt burden without doing anything to improve incentives for economic growth.
For more, see Howard Gleckman of the Tax Policy Center, and the White House's "Fact Sheet."

Update (1/25): Krugman has estimates on the distribution of the stimulus, which support the skeptical view.

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