America is at a crossroads. Congress, pressed by President Obama to act quickly to prevent “catastrophe,” is on the verge of spending more than $800 billion on a “fiscal stimulus package” intended to jumpstart the economy, with roughly $300 billion in tax rebate checks and $500 billion in infrastructure spending. Hundreds of economists, however, have expressed their deep concerns about the government’s plan for dealing with the recession, and a review of the effectiveness of such policies as those proposed reveals the folly of tax rebates and government spending as fiscal stimulus.
1. Tax rebates do not boost consumer spending. According to economist Martin Feldstein, CEO of the National Bureau of Economic Research, when tax rebates went out as economic stimulus last spring, only around 16% of the checks were actually spent, with nearly five times that amount going into savings. Most of the rebates were used to pay off loans, not to buy new products and services, and the stimulus package utterly failed to preclude the recession.
In 2001, tax rates were reduced and tax rebates went out to make up the difference. While the economy improved after the tax changes, evidence suggests that the rate reductions, not the rebates, did the trick. A late-2001 study conducted by economists Matthew Shapiro and Joel Slemrod of the University of Michigan and NBER found that only 22% of those households receiving stimulus checks spent the money.
Furthermore, by the time the checks would be in the mail, the economy may be improving, as happened, according to Steven Weisman and Edmund Andrews of The New York Times, in the 1970s. If implemented now, the benefits of a tax rebate stimulus—a small burst in increased consumer demand—are minimal at best and will not outweigh the substantial costs.
2. Faulty policy is not worth the debt risk. While the value of the dollar has lately gained in strength, it still has the potential to continue its recent decline. As its value goes down and creditors like China see their own GDPs shrink, creditor concerns over their holdings of U.S. bonds will rise, resulting in the likely increase in interest as they rethink their holdings. By spending $800 billion on a stimulus package that will likely have minimal effect, the U.S. government is essentially assuming even more debt, which is already at $10.7 trillion, at greater national risk.
3. Infrastructure projects will not work. Obama intends to spend around $500 billion on infrastructure projects and public works programs, including transportation projects, intended to create jobs and boost consumer confidence. Yet when Herbert Hoover and FDR tried such programs in the 1930s to tackle the Great Depression, unemployment remained in the double digits up to World War Two, averaging at 17.2%.
According to the Heritage Foundation, federal spending rose from “3.4% of GDP in 1930 to 6.9% in 1932 and reached 9.8% by 1940. That same year—10 years into the Great Depression—America's unemployment rate stood at 14.6%.” In sum, massive increases in government spending did not result in noticeable economic improvements.
Even if infrastructure spending were to have positive effects, an early analysis of the Congressional Budget Office found that just 7% would be spent by next fall, with only 64% reaching the economy by 2011—likely after the country has entered into recovery.
4. Japan’s “lost decade.” Japan’s “lost decade” of economic growth of the 1990’s presents an excellent case study for the suggested package. Over a period of seven years, the government implemented eight different, large stimulus packages much like Obama has proposed.
According to The Wall Street Journal, during the 1990’s, the Japanese government, faced with many of the problems we are confronted with today, tried giving out loans to businesses, boosting infrastructure spending, buying bad assets off of banks and distributing tax rebates, among other Obama-esque policies.
These policies resulted in an increase in Japan’s debt-to-GDP ratio from 68.6% in 1992 to 128.3% in 1999. In essence, government spending in Japan skyrocketed in ways very similar to Obama’s proposals, yet the economy did not experience noticeable improvements until the current decade.
5. An alternative proposal. The government must instead institute wide-ranging, permanent, pro-growth tax rate cuts, starting with making the Bush tax cuts permanent and expanding them. Beginning in 2010, the Bush rate reductions on income, capital gains (investments) and the estate tax will start to dissipate. With the dire need for capital injections into the market, allowing the 15% capital gains rate to return to the 20% rate would discourage investment in the economy. Instead, the capital gains tax should at least be cut in half to 7.5%, if not temporarily expunged for all investments begun this year and kept for no less than two years, so as to incentivize greater investment.
Former House Speaker Newt Gingrich has proposed that the 25% income tax rate be reduced to 15%, thereby “establish[ing] a flat-rate tax of 15% for close to 90% of workers.” Such targeted tax cuts would give the economy the boost it needs to create jobs and increase consumer demand and investment. We must then slice the corporate tax rate from 35%, the second-highest in the world, to 25%, the average in Europe. This would expand incentives for businesses to create jobs in America and lessen the enticement to outsource.
If the Bush tax cuts expire, taxpayers will reduce spending in anticipation of the expirations, stunting the benefits of the rebates further. Alternatively, the knowledge that tax rates will be cut and individuals will be permitted to keep more of their income will give a sense of comfort to the beneficiaries.
By cutting marginal tax rates now, the short-term effect will be a rise in consumer confidence, resulting in a boost in consumer spending. The long-term relief that came in the form of broad-based tax cuts in 2003 resulted in the largest single-quarter GDP growth in 20 years, 7.2%, and the creation of 8 million new jobs through 2007.
The president has disappointingly labeled such contentions against his plan “old,” “phony,” “worn out” and “tired.” Yet history has shown that the net benefit of such stimulus packages is minimal, and he who does not learn from history is doomed to repeat it.
A fiscal stimulus of tax rate cuts, not tax rebates or infrastructure spending, would stimulate an economic recovery by putting more money in people’s pockets long-term and increasing demand in the short-term. That is the kind of economic policy that would do America the most good.
Jimmy Sengenberger is a political science student at Regis University in Denver, a 2008 honors graduate of nearby Grandview High School, a national organizer for the Liberty Day movement, online radio host, and a columnist for the Villager suburban weekly. He is also College Liaison for BackboneAmerica.net, working through the Backbone Americans group on Facebook.