Thanks to Jeffrey for pointing out an opinion piece by Martin Feldstein in today’s Wall Street Journal, entitled “The Tax Rebate Was a Flop. Obama’s Stimulus Plan Won’t Work Either.” Feldstein points to what he considers a disappointing effect of the stimulus checks on household spending (emphasis added):
Recent government statistics show that only between 10% and 20% of the rebate dollars were spent. The rebates added nearly $80 billion to the permanent national debt but less than $20 billion to consumer spending. This experience confirms earlier studies showing that one-time tax rebates are not a cost-effective way to increase economic activity.
Feldstein cites recent aggregate (GDP) data as well as a household-level analysis by Christian Broda (U. of Chicago business school) and Jonathan Parker (Northwestern U. business school), all of which show that consumers don’t seem to be consuming that much.
Feldstein’s disappointment comes out of a narrow measure of fiscal policy “success” in this context as how much of an immediate, short-term boost to consumption is provided. That is indeed the concept of countercyclical “fiscal stimulus,” and that’s indeed how we came to giving out those stimulus checks. I’m just not sure how one starts with that definition of an effective stimulus, however, and gets to a call for more tax cuts for the rich. (A more effective stimulus, as Feldstein himself acknowledged before the stimulus was passed, would have steered a larger proportion of the stimulus dollars to lower-income households, via food stamps, for example.)
But there’s always a tradeoff in pursuing short-term boosts to the demand-side of the economy, because if consumption is encouraged, then saving is necessarily discouraged (at least temporarily). We can’t immediately increase both consumption and saving at the same time. Only through saving can we over the longer run increase consumption and saving at the same time (through higher incomes).
So how bad is it that only about 20% of the stimulus checks were immediately spent? I prefer to look on the bright side. First, Broda and Parker point out that the 20% is only within the first month after receipt and that their calculation does not include any potential multiplier effects (as those extra sales dollars translate into incomes for businesses and households and get spent again). Second, this immediate response is similar, or maybe even slightly higher than, the experience with the 2001 tax rebates, which Broda and Parker point out “have been credited with helping end the 2001 recession”–and which over six months eventually produced additional spending that was about two-thirds of the rebate checks.
But mostly, the bright side is that eventually, over even more than six months I mean, the stimulus checks will be spent, even if they’re immediately being saved. Spreading out the consumption made possible by the checks is not at all a bad thing for the economy in a broader-than-immediate-stimulus sense. What it means is that the stimulus checks were partly good for the short-term economy, and partly good for the longer-term economy. In an economy that faces current problems that are clearly not just cyclical in nature, it seems quite prudent to diversify our policy portfolio among pro-growth (longer-term) as well as pro-consumption (shorter-term) fiscal policies. And in an economy that’s so “gloomy,” would you really expect (smart) households to gleefully run into the stores with their rebate checks, to shop til they drop?
The fact that the stimulus package was deficit financed was already a dent into national saving, which was always a worry that thankfully kept Congress and the Administration focused on the “three Ts” (timely, targeted, and temporary) as criteria for cost-effective stimulus. To the extent that the stimulus checks “fail” to deliver immediate consumption, they “succeed” in providing some offsetting increase in personal saving (or decrease in personal indebtedness) and hence some increase in future consumption. And no matter how they are used, the stimulus checks have provided a small boost to the incomes of tens of millions of American families who were surely made better off by them. In that sense the stimulus checks will probably prove to be worth the price of $100 billion in additional debt, especially if we’re convinced the policy hasn’t jeopardized our prospects for economic growth over the longer run.
Feldstein segues from his critique of the tax rebates to a critique of the Obama tax plans this way (emphasis added):
The small rise in spending in response to these tax rebates is similar to what previous studies of one-time tax cuts found. It also corresponds to what both basic economic theory and common experience imply. Although someone who receives a permanent annual salary increase of $1,000 typically would increase his annual spending by an almost equally large amount, a $1,000 rise in wealth caused by a share price increase or a tax rebate would raise spending only gradually over a number of years.
All of the evidence on one-time tax rebates implies that the Obama plan to send $1,000 rebate checks would do little to raise consumer spending and stop the decline in employment. If the past is an indicator of what would happen, the $65 billion he proposes to spend on this plan would raise consumer spending by only about $10 billion, or less than one-tenth of 1% of GDP.
The distinction between one-time tax rebates and permanent changes in net income is also important for the debate about Mr. Obama’s proposal to raise income and payroll taxes. Because those tax increases would be permanent, they would cause a substantial reduction in consumer spending and aggregate demand. Moreover, as taxpayers begin to focus on the possibility of such a future tax hike, they will reduce spending without waiting for such legislation to be enacted. If Mr. Obama is looking for a way to stimulate the economy, he could begin by discarding his proposal to increase future taxes.
This is an odd line of reasoning coming from Marty Feldstein, who’s one of the best supply-side fiscal policy experts around, because he throws out all considerations of the supply side in this critique of the Obama strategy. First, of course a permanent annual salary increase of $1,000 (to be repeated over and over again) would surely increase consumption by more than a one-time $1,000 check, as in both cases the consumer tries to spread it out over time–and of course it would cost a lot more as well. (If you’re going to compare the economic benefits of a permanent tax cut with those of a one-time tax rebate, you have to consider as well the cost of the tax cuts and how they are financed.) Second, it’s not clear that Senator Obama would define “success” in his $1,000 rebate proposal the same way that (supply-sider?) Feldstein would–whether Obama views the goal or purpose of the rebate as having households immediately spend the money, rather than just having households immediately have the money (to spend over time as they choose). Finally, opposing Obama’s proposals to increase taxes (or not extend tax cuts) on supply-side grounds is one thing that can be debated, but it’s more than a little surreal to see Feldstein suggest here that such tax increases would be bad for the economy on demand-side grounds because they would decrease consumption (i.e., increase national saving).
It’s time to more thoughtfully consider the balance between short-term and long-term fiscal policies, in dealing with an economy that clearly has a mix of short-term and long-term challenges. As reported in this AP story by Martin Crutsinger, Congress will consider another round of stimulus when they return in September. See if you can spot the evidence of how much the economy is weighing on the minds of policymakers–and the press–in this part of Martin’s story:
House Speaker Nancy Pelosi says the House will vote on a second stimulus package when it returns in September from its August recession. The Bush administration opposes it in part because it could drive the budget deficit higher.