Visiting Fellow Bill Thomas
Research Fellow Alex Brill
Washington is abuzz these days with calls for economic stimulus. The presidential candidates are eager to "rescue" voters, and the administration doesn't want its final chapter to end on a sour note.
The current tax code--designed to discourage capital accumulation and projected to collect rising levels of revenue in increasingly complex and distortionary ways--does need serious reform. But what we're getting instead from politicians and economists are legislatively challenging, economically questionable and politically motivated policies to address a potential problem best handled by the Federal Reserve.
There are five principal reasons why a politically motivated economic stimulus bill should not be enacted in the middle of the presidential primary season.
Good public policy cannot be the result of a focus on micromanaging consumer demand to meet the objectives of the congressional and White House political calendar.
First, from a legislative process perspective there is no way that a tax cut can be enacted in the first quarter of 2008. Thus, fiscal policy action would come too late if one accepts the gloomiest economic forecast.
Tax cuts generally take at least six months to pass into law and can often take much longer. The Kennedy tax cut in 1964 took more than a year to enact. The Reagan tax cut in 1981 took eight months time from when it was first proposed to when it was enacted. The 2001 tax was first developed on the campaign trail in 2000 and the $600 rebate checks that were intended as a stimulus component to that bill were only mailed in August and September 2001.
Second, perhaps the easiest "stimulus" package Washington could to enact would be to drop money from planes into the hands of voters/consumers. However, the economic evidence from the 2001 experience suggests this is an ineffective tool. Professors Matthew Shapiro and Joel Slemrod from the University of Michigan found that most rebates were saved, not spent. While this result may be a disappointment to those of us who thought this approach would be effective, Congress must be willing to learn from past legislative experience. Popular versus effective is sometimes the difference between politics and economics.
The 2003 tax cut, which has been shown to have delivered a significant positive economic punch, lowered the tax rate on capital gains and dividends to 15%, accelerated the reduction in tax rates on labor, and offered businesses 50% bonus depreciation to stimulate investment. While it took just six months to be enacted, it required tremendous political valor on the part of many, and political strength on the part of others.
Even so, it passed by just one vote in the Senate in the final days of the second quarter of that year. Both the 2001 and 2003 tax cut bills were enacted in an environment when majorities in Congress did not subscribe to straightjacket pay-as-you-go budgeting and forecasters projected out-year budget surpluses.
Third, the 2003 tax cut was enacted in an environment when monetary policy was possibly near the end of its rope. The federal funds rate was 1.25%, and the Federal Reserve had only untried and unusual policy remedies left.
Not so today. The fed funds rate currently sits at 4.25%. Fed Chairman Ben Bernanke has recently emphasized that "more pronounced responses" and "stronger action" may be appropriate for the Fed given the uncertainty arising from a range of possible future economic outcomes. Yesterday Mr. Bernanke cautioned Congress about the risk of stimulus that comes too late and could be "actively destabilizing."
The Fed has also been shown to be flexible in its actions. The recently launched Term Action Facility provides another tool to aid the real economy through monetary policy. Taken together, Chairman Bernanke appears better positioned, better equipped, and more willing to quickly inject significant monetary stimulus than his predecessor.
Fourth, although the political calendar suggests that now is the time to launch the stimulus debate, the economic data are far from compelling. While some on Wall Street have recently issued forecasts for recession, the data to date only indicate elevated risks.
To be sure, in December, job growth slowed and retail sales (excluding ever rising Internet sales) were weak. However, our labor markets are flexible and our economy is dynamic. As a result, there will always be workers in particular industries or in certain geographic pockets who are experiencing difficult times or "personal recessions."
Congress should explore public policy that will encourage those workers to find new jobs, acquire new skills or relocate to more prosperous locations. That too should be the focus of debate this year. Good public policy cannot be the result of a focus on micromanaging consumer demand to meet the objectives of the congressional and White House political calendar.
Finally, it is important to consider the potential economic consequences of failure to achieve a legislative objective. The amplified rhetoric of economic doom from leaders and hopeful leaders in Washington may become a self-fulfilling prophecy as consumers curtail their spending in response to the predictions of recession by their favorite candidates. If history is a guide, economically sound help from Washington will arrive late at best and likely not at all.
Bill Thomas is a visiting fellow at AEI. Alex Brill is a research fellow at AEI.