Is Saving Your Tax Cut Such a Bad Thing?

12.01.2009

Business Week's Michael Mandel makes a great point:

The conventional economic wisdom these days seems to be that tax cuts or tax credits are bad because people save the money, rather than spending it. ...

But this conventional argument misses the whole point. Consumers have a massive hole in their balance sheets these days. Home prices are plunging, incomes are slowing, and many families have huge debts. Americans are staggering.

From this perspective, the main purpose of the tax cuts and tax credits is to help repair consumer balance sheets, just like the TARP is helping repair bank balance sheets. I don’t want consumers to spend the tax cuts—I want them to save the money, as much as possible, and get their debt back to reasonable levels. That’s the only to ensure that consumers will be on solid ground when the recession is finally over. ...

[T]he three prongs of the stimulus package serve distinctly different purposes. The TARP recapitalizes the banks, with $700 billion. The tax cut, at $300 billion, recapitalizes the consumer. And the government spending program—say, $500 billion—provides the missing demand and jobs.

I think there's a lot of truth to that. My lone quibble is that government spending can accomplish both things--recapitalization and goosing demand--by creating jobs and higher incomes, some of which people will save, some of which they'll spend. But I don't think Mandel would disagree. And it's not crazy to want some of the recapitalization to happen soon. It's often a precondition for consumers to spend again.

You hear a lot of talk about how saving is a bad thing. And it is in the narrow confines of a stimulus conversation. But if people are so quick to save any money they stumble across, it's often because they're dug in under a lot of debt. Which means digging them out should be a priority, too.

(Via RCP.)

--Noam Scheiber

Posted: Monday, January 12, 2009 4:19 PM with 8 comment(s)

Comments

You must be logged-in to comment.

Not a subscriber? Click here to get a digital or print and digital subscription to The New Republic!

roidubouloi said:

This is one of the stupidest things I have ever read. Think about the lost wealth and ask yourself whether tax cuts could possibly make a dent. The answer is no. Not only that, if we get back to full output, it won't matter that that paper wealth has been lost as, by definition, we will have reached equilibrium again based on a lower nominal wealth. Also, you cannot increase the wealth of the country by having everyone owe something to everyone else, as happens when the government borrows and then gives it out to more or less everyone. Unless there are net winners and losers from that sort of transaction -- some transfers somewhere -- it is meaningless in terms of wealth. Finally, even in terms of the impact of "wealth effect" on spending behavior, this is ass backwards. There is some relatively modest percentage of wealth that gets spent at the margin. Thus, even if magically all of the lost wealth could be restored, you still get only a small percentage of that as spending. Instead of a multiplier effect, where a dollar of government expenditure produces a multiple of that as additional output, you get a "de-multiplier" effect in which a dollar of government largesse produces much less than that as spending rendering it impossible to move the economy.

Did I mention how stupid this is? All it proves is that business interests are still drinking the Reagan Kool-aid, even now, when the only thing those improvident tax cuts have produced are asset bubbles that have wrecked the economy.

The fastest way out of the current mess is not tax cuts, but government expenditures. The fact that tax cuts don't get spent is why government expenditures have much more of an impact on the economy. Of course people have good reason to save their tax cuts, but that does not mean that the macro effect of their doing so is what we need or want. Rather than cut taxes, we should raise taxes on the rich who don't even spend all their income in order to minimize the interest rate impacts of the massive government spending we need. That is, don't borrow the money from the rich, take it from them. (Lest anyone start babbling about socialism, I quite tidily in the class that would pay more in taxes if the Bush tax cuts were repealed. They were hideous policy then and the longer they stay on the books, the worse off we are going to be.)

January 12, 2009 5:50 PM

iambiguous said:

Do you have any personal experiences living from paycheck to paycheck? Tell us what worked for you.

You know,.as you wavered back and forth between saving and spending. Maybe those folks barely hanging on from week to week can manage to both spend and save. How? Well if the folks on Wall Street can be "recapitalized" to the tune of hundreds of billions of dollar, why not recapitalize the folks down on the lower rungs of the economic ladder? With, say, $10,000. That way they CAN spend and save at the same time.

george walton

January 12, 2009 6:15 PM

desperjm said:

I for one am tired at the public prodding for the American consumer to buy more! IMHO it's an honorable public duty for me to consume no more than I can afford. If I'm overextended I'll surely use any tax break to close the gap.

Until we realize that we, as a nation, are consuming more than we are producing, then any government plan will fail in the long room. Yes, I'm in favor of government stimulus at this time, but long-term this stimulus will have to be paid for. (Perhaps sooner than long-term: the Chinese are making noises about buying fewer of our Treasury bonds....)

January 12, 2009 6:45 PM

nbarry said:

Part of the problem is that consumer spending is considered a positive economic indicator even if it results in maxed out credit cards. A much truer and more reliable indicator would be consumer debt, but business interests don't like to hear about it. As Mr. Micawber said, a penny of expenses less than total income equals happiness. A penny of expenses greater than total income equals misery.

January 12, 2009 8:49 PM

cthulhu2008 said:

Tax cuts are only effective if they are acompanied by reductions in spending. Otherwise its just giving people money, a sort of welfare. Its strange how the political debate over taxes does not mention this crux problem.

January 12, 2009 11:33 PM

George:

You realize of course you are disgracing everything America stands for with an attitude like that. It's probably illegal in some parts of the country.

Try this:

1] sit in front of a television 24/7 for a month [maybe two] and watch the same 27 commercials they air over and over and over again

2] try to understand WHY you should buy these things. They wouldn't interupt reruns of Seinfeld and MASH if there wasn't a good reason TO buy them, right?

3] drive around in your car and count all the places that 10 years ago no one had even thought to put advertising on. Then come up with a list of places even they overlooked. The idea of course is to keep your brain thinking constantly about buying stuff.

4] sit down at a table and write down all the ways you would advertise products better. Whenever you think your way IS better than their's go out and buy it

5] make a game out of it. Go to a Walmart. Starting with the letter A, see how far you can get in the alphabet before you run out of money. Each day try to go a littler farther.

6] invent new things to buy. Then, after you invent them, go on TV with an infomercial. All you have to do is hit the jackpot once and the money will start pouring in. You will never, ever have to stop buying things for the rest of your life.

January 13, 2009 1:33 AM

Just out of curiosity, what's the difference between an economic plan that is the "stupidest" thing you have ever read, and one that is the "dumbest"?

Barack Obama, you'll recall, thought the war in Iraq was a "dumb" idea. Not stupid, dumb.

Which is worse?

After all, soon Obama will be in the Oval Office. The new The Decider. And lots of people will want to know if what he does is stupid instead of dumb or dumb instead of stupid. And, perforce, which we should worry about more.

In other words, I for one am counting on you to tell me when my fear should metastasize into a full blown panic.

I mean, it's not like it isn't going to be one or the other, right?

January 13, 2009 1:53 AM

jsincalif said:

Read my lips: No New Tax-Cuts!

Great to see roidubouloi contributing to what seems to be a rising tide of intelligent and principled opposition to the (well-intentioned) tax-cuts in the Obama stimulus plan. I believe that Paul Krugman also just made a high-profile criticism of those tax-cut proposals as well.

As Obama himself said during the campaign, we cannot do the same things over and over and expect a different result. What we have done for the last eight years is enact huge tax-cuts, engage in enormous federal borrowing, and distribute a large deficit-funded tax-rebate package. What we have gotten is two recessions and very poor economic performance over the entire period. So, why should we expect more tax-cuts and more deficit-spending to produce a different result now?

Large-scale public-spending may indeed be needed now (as long it is directed into programs that are intrinsically valuable). But as much as possible, it should be funded by tax-revenue, not by more borrowing.

The deleterious effects of federal budget deficits have been described often, but perhaps bear repeating again. Large federal borrowing competes for limited funds available for loans, driving up interest rates, which inhibits all types of economic activity. Increased American interest rates increases foreign demand for dollars, which raises the value of the dollar relative other currencies, which hurts American exports.

Furthermore, dependence on foreign borrowing makes the U.S. vulnerable to decisions made abroad. For example, if China or Japan decided to sell large amounts of the American government securities that they hold (say, to purchase more of some dollar-denominated commodity, like oil), it would have big economic repercussions here.

In contrast, reducing federal deficits would not only counter these problems, it would also raise general confidence in the responsibility and reliability of government financial decision-making. Such improved public confidence would produce more fluid investing and lending.

Not only should there not be new tax-cuts, but also the irresponsible Bush tax-cuts should be repealed. (And remember, few seriously complained about Clinton-era tax-rates at the time, other than movement-conservatives and unrepentant supply-siders.)

Furthermore, tax-rates on unearned income (e.g. capital gains) should be the same as those on earned income (e.g. wages). As per Economics 101, creating externalities like different rates of taxation for different sources of income inevitably skews economic activity so as to introduce inefficiencies and misallocations of resources. Income is income, regardless of its source, and it should all be taxed in the same way.

Tax-cuts should be eliminated from the Obama plan in the aggregate, based on these fundamental and broadly applicable principles. Besides that, certain particular intended tax-cuts, as per the plans described at www.change.gov, are especially inappropriate. As I have described in a post to an earlier article, some of these are:

1) New American Jobs Tax Credit

Jobs need to be offered in response to actual business need, not government subsidy, for them to actually contribute to the economy and to be productive and sustainable. Anyway, the $3000 credit per job is not enough to actually induce businesses to hire more people. Accordingly, these credits would simply reward businesses for hiring they would have done anyway, without such credits. As such, this would be a big cash giveaway, on the order of tens of billions of dollars, to no positive end.

2) Zero capital gains rate for investment in small business.

As per Economics 101, economies work efficiently when economic decisions are based on the intrinsic economic merit of those decisions, and not skewed by externalities, such as special tax preferences for certain actions. Decisions to invest in small businesses, or in any other businesses or economic activities, should be based on their intrinsic economic merits, not on relative tax advantages. When such tax-advantages are introduced, then decisions inevitably skew investments in ways contrary to what would best fit and respond to economic conditions and realities. Taxation of all investments, in fact of all income, should be subject to uniform taxation regimes, so as not to artificially skew incentives in ways that inevitably worsen investment decisions.

3) Special tax-rates for seniors

Why should income tax rates be based on age? All people of all ages face various challenges. There is no economic or moral reason why people of one age should have more favorable tax-rates than people of another age. Income tax-rates should be based on income levels, period.

4) Suspending taxation of unemployment benefits.

Definitely unemployment benefits should be extended; during recessions it takes much longer for people who lose jobs to find new employment. But, there is no reason why those benefits should not be taxed, just like all other income. For many, those unemployment benefits might even be higher than the wage-income of others who are working. Why should people with low wage-income have to pay more taxes on their income than people who are receiving higher income from unemployment benefits. Income is income. The rates of taxation of all income should be based on income levels, not on the source of that income. This is not only fair, it also promotes the sense of a shared fate and a shared responsibility for the overall society.

5) Exempting 401k and IRA withdrawals from taxation

The contents of 401k and IRA accounts have already had favorable taxation treatment all along, since they were initially invested. There is no reason why these particular funds should get even more special tax-treatment by being exempted from taxation upon withdrawal. Why should they get even more special treatment relative to investments people made outside such tax-favored accounts? Many people did not even have 401k plans available to them, so they could not even make such investments. Again, income taxation rates should be based on income levels, not on the source of the income.

And we should remember that this economic crisis began with the mortgage-repayment crisis; successfully addressing the former will require sufficiently resolving the latter.

January 13, 2009 3:31 AM