As fears of a pending recession set in on many Americans, George Bush has pushed Congress to come up with an economic stimulus package to help spur the economy. The deal they have announced revolves around tax “rebates” in the ballpark of $600 to $1,200 for most filers. The goal is to inject more money into the economy with the hopes that it will lead to increased consumer spending. I must admit, when I first heard the idea floated around last week, I was excited about the prospects of getting my rebate check (I desperately need a new TV). As I have thought about it longer however, I realize this plan is the equivalent of putting a small patch over a large hole.

For starters, the idea that these rebates will “inject” new money into the economy is absurd. A tax rebate adds just as much “new” money to the economy as an increase in welfare payments would, and that is zero. In order to facilitate this rebate program the government first had to collect money, i.e. pull money out of the economy. In actuality, this stimulus package will have about the same affect as taking money from your right pocket and putting it in your left pocket.

As Don Boudreaux notes:

Such stimulus, however, is futile. Government cannot create genuine spending power; the most it can do is to transfer it from Smith to Jones. If the Treasury sends a stimulus check to Jones, the money comes from taxes, from borrowing, or is newly created.

If it comes from taxes, the value of Jones’s stimulus check is offset by the greater taxes paid by Smith, who will then have fewer dollars to spend or invest. If Uncle Sam borrows to pay for the stimulus checks, this borrowing takes money out of the private sector. Any dollars borrowed – whether from foreigners or fellow Americans – for purposes of stimulus would have been spent or invested in other ways were they not loaned to the government.

As we look at the plan itself we see that not all tax filers are eligible for the “rebate”. Generally speaking anyone earning over $75,000 is left twisting in the wind, while those who earned as low as $3,000 will be eligible for some form of rebate. The use of the term tax rebate in this scenario is a smack in the face to anyone who has ever taken a high school economics course. A tax rebate is defined as “The refund of a tax that has been overpaid“, how then can someone with no tax liability be eligible, while someone in the highest tax bracket is not?

The underlying premise behind the tax rebates is simple enough to understand. Put more money into the hands of consumers and they will spend more, thereby leading to economic growth. Ironically it is the same politicians who wish to spur economic growth by injecting money into the economy who also are responsible for pulling the money out of the hands of consumers in the first place.

A true stimulus package should have at its heart a permanent extension of the Bush tax cuts. Assurances that tax rates would not rise in 2 years would offer greater incentives for investments, which would then stimulate the economy. Much like the problem we are continually encounter with the alternative minimum tax (AMT), our elected leaders have chosen a short term patch over a long term solution.

If you enjoyed this post, make sure you subscribe to my RSS feed!

Congress, Features, Politics, Taxes