January 16, 2002

President Bush and Senator Daschle both are stumping for variations of a tax stimulus package as Congress comes back to work.  There is only one problem.  Neither has any idea what a tax stimulus package should be. 

  The idea of a budgetary stimulus to jumpstart a faltering economy has been endorsed by economists at least since Keynes and maybe even Ricardo or Corbert.  The Keynesian version of the argument is simple. When private spending falters and people and machinery are unemployed, a push should be made by the public coffers to reverse any downward spiral and push the economy back toward sound levels of activity. 

  You do not continue to push after the economy has found its own momentum.  Moreover, you are overcoming resistance, such as inadequate spending capacity, liquidity shortfalls, or profit collapses. 

  Stimulus packages are not reform legislation that eliminates long term restraints or solves persistent social problems. 

  They also are not spending or tax reduction programs that are permanent.  The reason why the Keynesian version should work is that any borrowing needed by the government to fund the spending and/or tax cutting initiatives will have minimal impact upon interest rates during recession.

   I have argued forcefully that interest rates do rise with government borrowing during sustained expansions.

  Thus, the keys to a stimulus package are that it is timely (we don't solve the problem well after it already is resolved), temporary, and offsetting private shortfalls. 

  The House version of the stimulus package includes the elimination of the corporate alternative minimum tax, changing depreciation schedules, lowered capital gains taxes, and acceleration of some tax cuts already enacted but not yet effective. 

  The corporate alternative minimum tax may be creating long term distortions, especially as its provisions are not adjusted for inflation.  (The same problem exists with the personal AMT).  This is a problem that belongs in a reform bill, not a stimulus bill. 

  A reform bill also should contain the depreciation schedule changes.  However, the correct measure for a stimulus package, a temporary investment tax credit for incremental spending, has been so abused politically that it apparently can no longer be discussed in the halls of Congress. 

  Therefore, I would reluctantly accept the depreciation changes as a second best solution to entice corporations to build up their capital spending programs. 

Capital gains tax reductions increase stock transactions in the short run and only add to investment holdings over time.  This is exactly what should not be in a stimulus package. 

  Democrats must get off their high horse about rich corporations (do they include those going bankrupt) and recognize that capital spending shortfalls are contributing to economic weakness.  You prop up the part of the mine shaft that is falling.

  Accelerating tax cuts only increases the government deficit in the short run.  As those cuts would have occurred anyway a few years later, this pushes the stimulus to where it could be more effective.  Indeed, if economic activity responds, government borrowing may actually be lower than originally projected when the originally scheduled time for the tax cuts comes around.

  Therefore, such accelerations of the omnibus tax provisions makes good economic sense in a stimulus package.

  As a rule, spending programs do not work well in a stimulus program because the contract and spending cycle usually delays the economic impact until recovery is underway.  Furthermore, the haste of the spending usually leads to less desirable projects, as Japan has discovered in its many attempts to use construction spending to jumpstart their economy. 

  Studies show that the stimulus package passed during the Carter administration actually had its greatest impact when inflation, not recession, had become the problem.  The Carter program added to economic instability when it was supposed to do the opposite. 

  Those education construction programs pushed by the Senate belong in education appropriations, not economic stimulus.  On the other hand, the extension of unemployment benefits not only has precedent, but  is appropriate. 

  Recessions make job search less fruitful (though search definitely must be done).  Therefore, lost purchasing power exists longer than when jobs are lost in a normal expansion.  Adding weeks of eligibility should be encouraged.  Indeed, a law that would automatically do this when claims rise above recessionary levels (currently about 400,000 per week) and remove the special provisions when claims fall to 350,000 per week on a four week average could provide automatic adjustments. 

  Unfortunately, the Senate tried to add provisions about medical insurance to their package.  Protecting medical insurance for unemployed workers is laudable, but should not emerge in a stimulus package.  Again, this is new law and should be in some reform measure. 

  Ultimately, the whole stimulus issue was stalled on how to purchase the medical insurance for the unemployed.  Should it be the employer's program (who needed to lower costs by shedding workers) or credits for open market insurance purchases?  This is not a stimulus provision. 

  Because there are glimmers of improving economic activity, I would scrap the entire stimulus program as being too late to aid economic stability.  If politics dictates that one is passed, then it should contain only extended unemployment, some depreciation schedule changes, and some acceleration of the already enacted but not yet effective tax cuts. 

  Put the health insurance, AMT, and other issues into reform legislation and see if that is what the public wants.  I am ready to teach my course on stimulus legislation whenever the Congress and President are ready to listen. 


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