A Chequer-Board of Nights and Days

I was against the idea of tax rebates from the time they were discussed as a way to stimulate the economy. If you don't believe me, feel free to read this. As I wrote, "if we really want to stimulate the economy, we need a permanent tax cut." The tax rebate certainly was not permanent and based on Milton Friedman's past research on this issue, I was convinced that it would not work.

Martin Feldstein, who chaired the Council of Economic Advisers under President Reagan, was convinced that the tax rebate would work. Martin Feldstein is, of course, an exceedingly smart man and he has forgotten more economics than most people will ever learn. But on the rebate, Feldstein has come to the conclusion that he was wrong to have endorsed it:

Congress enacted the tax rebate program earlier this year because it perceived a growing risk of recession. In addition, it feared monetary policy alone would not be effective because of the dysfunctional credit markets. As American taxpayers know, most of the rebate checks have now been mailed and cashed.

Those of us who supported this fiscal package reasoned that the program would boost consumer confidence as well as available cash. We hoped the combination would cause households to spend a substantial fraction of the rebate dollars, leading to more production and employment. An optimistic and influential study by economists at the Brookings Institution projected that each dollar of revenue loss would increase real GDP by more than a dollar if households spent at least 50 cents of every rebate dollar.

The evidence is now in and that optimism was unwarranted. 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.

Friedman predicted that one-time rebates would be used primarily to pay down debt or for savings. This is pretty much what happened here--thus Feldstein's observation that "only between 10% and 20% of the rebate dollars were spent." Note the following from Feldstein's editorial:

For a more comprehensive picture, we can see how households divided their overall increase in disposable personal income -- that is, household income including the rebates and net of income taxes and payroll taxes -- between additional consumer outlays and saving. The official GDP figures show that disposable personal income increased between the first and second quarters by some $98 billion (one-fourth of the annualized figure of $393 billion shown in the government report), up from an increase of $22 billion between the final quarter of 2007 and the first quarter of 2008. So disposable personal income rose by an additional $76 billion, a bit less than the rebates because of declining employment and reductions in other sources of income. The corresponding rise in consumer outlays increased to $36 billion from $24 billion. So the additional $12 billion of consumer spending was less than 16% of the extra $76 billion of disposable personal income. By comparison, savings rose by $62 billion, or five times as much.

(Emphasis mine.) Now, there is no use crying over spilled milk. However mistaken the rebate idea was, there is no walking it back anymore. We have to learn from our experience, recall that Milton Friedman is proven right yet again and refrain from making the same kind of mistake in the future that we made with regard to the rebate.

Kudos to Feldstein for helping us do just that. From the failure of the rebate, he draws the following entirely proper, appropriate and intellectually on-target observation:

These conclusions are significant for evaluating the likely impact of Barack Obama's recent proposal to distribute $1,000 rebate checks to low- and middle-income workers at an estimated cost of approximately $65 billion. His plan, to finance those rebates with an extra tax on oil companies, would reduce investment in refining and exploration, keeping oil prices higher than they would otherwise be.

[. . .]

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.

Now, if we have a press corps that wants to show its relevance, its value, its ability to question seriously and dig deeply for facts, if we have a press corps that is willing to place politicians in intellectually uncomfortable positions by pointing out all of the ways in which their various plans just do not add up, then said press corps will confront Barack Obama with Feldstein's arguments and ask him how on Earth it is possible that Obama's one-time rebate plan will defy the established iron laws of one-time rebates and actually add any significant value to the economy.

Let's see if said press corps goes ahead and does that. Feldstein and Milton Friedman before him have done all of the legwork necessary to arm the press corps with facts, figures and intelligent questions. All that awaits is the asking of those questions.

The faster and the more insistently they are asked, the better, of course.