The Problems with Short Term Stimulus Packages

Recently there has been a lot of talk about a short term stimulus plan to help the economy, while this goal might be noble, the problem with it is that there only a very limited about of effect that the short term stimulus package can have on the economy. A short term stimulus policy is based off the idea is that if you give people or business a temporary payment, tax rebate, tax cut or investment tax credit, that while spend or invest all of it or at least the vast majority of it. The problem is that this rarely happens, the evidence from most of the economic literature shows that this does not happen, most people do not change there spending decision based off short term changes in there income, they are more focused on long term changes and outlook for their income. Business are even less likely to base investment decision off of short term tax credits, as the evidence from the history of the investment tax credit that had little effect on business investment because of there short term nature. The problem with statistic like those that CNN had today that showed that consumer spent 2/3 of there 2001 tax rebate is that it only looks at whether or not people spent the “check”, not if they increased there overall spending, in many case people were going to spend that same amount any way, they just spent it earlier and their overall spending did not increase.

I can understand the political reasons behind the short term stimulus package, no one in government wants to look they are not trying to help, but if they must pass this stimulus package, afterward they need to move on to the long term government issues that are harming our economy, over spending, budget deficit year after year, bad government regulation and the problem with the tax system.

The Problems with Short Term Stimulus Packages

Recently there has been a lot of talk about a short term stimulus plan to help the economy, while this goal might be noble, the problem with it is that there only a very limited about of effect that the short term stimulus package can have on the economy. A short term stimulus policy is based off the idea is that if you give people or business a temporary payment, tax rebate, tax cut or investment tax credit, that while spend or invest all of it or at least the vast majority of it. The problem is that this rarely happens, the evidence from most of the economic literature shows that this does not happen, most people do not change there spending decision based off short term changes in there income, they are more focused on long term changes and outlook for their income. Business are even less likely to base investment decision off of short term tax credits, as the evidence from the history of the investment tax credit that had little effect on business investment because of there short term nature. The problem with statistic like those that CNN had today that showed that consumer spent 2/3 of there 2001 tax rebate is that it only looks at whether or not people spent the “check”, not if they increased there overall spending, in many case people were going to spend that same amount any way, they just spent it earlier and their overall spending did not increase.

I can understand the political reasons behind the short term stimulus package, no one in government wants to look they are not trying to help, but if they must pass this stimulus package, afterward they need to move on to the long term government issues that are harming our economy, over spending, budget deficit year after year, bad government regulation and the problem with the tax system.

The Economy

Today Ben Bernanke called for Congress to intact a fiscal stimulus plan, this is in line with traditional Keynesian programs to “correct” economic downturns and in theory it sounds good, but in practice they rarely work out as well as they should. The first reason that it will probably not have much effect is the size of the package, 150 billion dollars, while that sounds like a lot of money one has to remember that the total size of the United State economy is around 13 trillion dollars, so this package would only be the equal to slightly more than 1.1 percent of the US economy. The next problem is that the package calls for tax rebates; a tax rebate is when the government gives a person an advance on future tax refunds, it’s not a decrease in tax rates. In Keynesian economic this short term increase in people wealth will cause them to spend more and increase economic activity, the problem with this that people are not stupid and they realize that they will have to pay back this tax rebate or it will be taken out of there future tax refunds, so they realize that they have not had a real increase in there income and they do not increase there spending. Empirical evidence from President Bush earlier 300 tax rebate, in 2001, and from when the first President Bush reduce tax withholding to try and encourage spending, show that a large portion of the American public did not increase there spending any in response to short term tax rebates or reduction in tax with holding that were not accompanied by real cuts in the tax rates. Along with this the Fed should quite cutting interest rates, interest rates in the United State are already quite low and there already some evidence of rising inflation. On the plus Bernanke called to have the earlier Bush tax cuts made permanent.

Instead of short term fiscal stimulus package, the Government should be working on correct the action that it has made that has harmed the United States’ economy. First the United States Congress and the President needs to bring its spending under control and balance the budget, reducing the deficit and in the long term keeping the debt under control. Secondly by keeping spending under control, the Government should then move on to keeping taxes low and improving the country’s infrastructure. Doing these in the long run would do far more to improve the US economy and the lives of the common person than short term stimulus package. The United States needs to move beyond the failed Keynesian policies of the past.

Capital Projects

This is my first post of the New Year and much over due. Another year has gone by with out the Illinois State General Assembly approving a Capital Improvement program for the State of Illinois. While the problems with the Chicago area mass transit system, which was largely caused by mismanagement on the part of the officials, appointed to run it, the poor state of Illinois capital infrastructure has gotten less attention. Keeping up and improvement of the State’s Capital Infrastructure is one of the most important things that the state can do to promote economic growth. A good capital infrastructure program would increase the quality of the transportation network in the state and its schools. The improved transportation network in Illinois would make it easier and less expensive to ship goods with in Illinois and to ship goods into and out of Illinois making Illinois a more attractive place for business to locate. Illinois declining capital infrastructure has already cost the state a thousands of jobs and prevented some companies for locating here, including at least one major Japanese car company.