Stimulus-Part II

In the last post, I had berated that tax cuts are ineffective. However, tax cuts are also a virtue in some cases as I shall shortly put forward. Reagan's supply side economics had its time but tax cut seekers should realize the limits when demand slumps.
When are tax cuts most effective? Any conservative would argue that it creates incentive to work and hence improves long run productivity. They also argue that tax dollars are best spent by society individually rather than government deciding how to use it. Both these have their merits. But neither is a reasonable stimulus. Also government has to step in to make good for the collapse in private demand, to prevent a deflationary spiral.
Even for a stimulus however, there is a need for tax cuts to boost consumption. First, there may not be enough "shovel-ready" projects for government to spend on. Second, if tax cuts are properly directed properly then people may actually spend it. In that way, targeting lower income people is a good start for stimulus tax cuts. That is one place that Obama has actually correctly identified.
On the politics now- why is PEBO doing this? Does he really think that Senators like Shelby, DeMint, Coburn and other southern GOP senators are really going support this stimulus? Well, they would want the whole package to be only tax cuts rather than the present 40%. Next they will argue that we need cuts in business, capital gains and wealthy people's taxes. Then they will call cuts for non income tax payers as socialism. So, the whole thing seems such a waste. Of course, none of these tax cuts would be sufficient stimulus in the short term. And the poor would suffer inordinately.
However, the tactic may be that by agreeing to look at GOP proposals and proposing tax cuts he can call the GOP's bluff and make this into a wall street vs main street fight. That is a sure fire winning argument for Barack. But this approach carries too many risks. Most importantly, politics could threaten the entire economy. In my opinion, and in the next post I intend to quantify this, the size of stimulus, and its composition is not enough. We MUST err on the side of more rather than less stimulus.

Stimulus- Part I

The president elect is just revealing his plans for his first important legislation: the stimulus. And I am afraid it is poorly designed, at least at first glance.
Lets start with the tax cuts: 40% of the package to draw "considerable" GOP support. For starters, despite all the ramblings of conservative intellectuals on the vices of government spending and the virtues of tax cuts, it is indisputable that the multiplier effect on the economy by spending is greater. A conservative (no pun intended!!) value of the multiplier would be 1.2. This is assuming that most spending is pork, useless etc.
For tax cuts, the best case is a multiplier of 1. Why? For one, when people get tax cuts, they dont spend in times of crisis. They use it to draw down debt (pay it off), and spend on essential commodities. Not blaming the consumer, for whom it makes perfect sense, but a poor stimulus. If you wanted further proof, just look at the stimulus passed in 2008. The economy recovered for one quarter and then anemically shut down. Now, this was at a time when people where still optimistic. Anyone bets that times are better now???
Business tax breaks, as suggested add little as incentive. By allowing losses offset with past taxes, you are merely transferring wealth. What stimulus is that?
This is not to suggest that all tax breaks are bad, or that the stimulus should avoid them. Indeed this much better than Bush's tax cuts for those who dint need them and were not even asking for one. I will address this issue and the politics behind it in detail in the next post.