Effect of Tax Rebates on the Economy

There is a lot of differing opinion going on about the effect we will see from the stimulus package. Here is a pretty good overview of the situation:

Tax rebates really will boost economy, for a while
Analysis: Like a shot of caffeine, stimulus could wear off

There's a lot of skepticism in the country about how effective the $168 billion fiscal stimulus package will be, but economists who've crunched the numbers say it will give the economy a much-needed boost in the middle of the year.

"It could make the difference between a short and a long recession," said Mark Zandi, chief economist for Moody's Economy.com.

Per the multiplier theory, the $168 billion package should have an impact of five times that amount ot about $840 billion on the economy in the short run, pushing the aggregate demand curve outwards for a while.

However, you have to remember that this money is not just coming out of the blue--it will be paid from future taxes. Which means we are borrowing it. Which means it increases demend for credit, increases inters rates and inflation. Also, there's the issue of how enduring any stimulus effect will be.

President Bush signed the stimulus legislation Wednesday. It has three main features: 1) a tax rebate of up to $1,200 per working couple, plus $300 per child; 2) tax breaks for businesses to invest in capital equipment; 3) provisions to make more expensive mortgages available through FHA, Fannie Mae and Freddie Mac.

The business tax breaks are retroactive to the first of the year, while the individual tax rebate checks will arrive this summer. As for the mortgage provisions, the agencies haven't even begun to write the rules they'll follow for taking on bigger loans.

The rebate is months away and may just pull future spending forward, not expand the economy. I highly doubt folks will make long term spending decisions bases on a $1,200 one time check. It's anybody's guess how much will end up in lottery tickets and the like rather than durable goods purchases.

Surveys show most consumers say they'll save the tax-rebate money, or use it to pay down debts. Only a minority of consumers say they'll spend it. To be an effective short-term stimulus to the economy this year, the money would have to be spent.

Not entirely true. If folks pay down debt then they improve their financial health, which obviously is a good thing.

Also, as long as the money goes into the banking system, you get the expansion factor of the multiplier happening, i.e., banks have more deposits so they make more loans that get spent, which then goes into other banks and so forth. The best analysis I've seen so far is this:

Mike Englund of Action Economics says the rebate will amount to a one-time 18% increase in monthly pay. The impact of the rebates in the summer will be similar in size to a second holiday shopping season if consumers spend half of the windfall over a few months, Englund said.

The rebate might work almost too well, by pulling consumption and investment that would have taken place next year forward into this year.

Bottom line is I think this will have some positive effect in the short run, but with a long-term price tag. This is like a person feint from hunger eating a candy bar. There will be a short-term surge in energy followed by the sugar crash if more filling food is not eaten in the meantime.

This package may buy a little time to soften the potential coming recession, but you still have to fix the underlying problems of an economy that hav to be readjusted after an extensive period of growth.

The stimulus package is not a cure--it treats the symptoms and not the cause.