January 27, 2009

How Obama's Middle Class Tax Cut Will Save Jobs

Debate has intensified in the last few days about whether the Obama tax cut proposals in the stimulus package will be effective as a stimulus.

Among the majority that believe a stimulus package will indeed create and save some jobs on net versus no stimulus, the big issue is whether the stimulus size is enough to counter the large fall in consumer demand, and thus prevent higher and higher joblessness.

Keynesian stimulus in a nutshell is that government spending can increase demand in the economy to replace the fall in demand during a recession, saving jobs and creating jobs.

Several important side debates have been ongoing, and let's quickly dispose with a couple of those and get back to the main question of this post.

Objection A) Government spending does not create new jobs, since it relies on taxing or borrowing which in turn removes money or available investment and discretionary funds from the general economy -- simply shifting spending and investment from one place to another without a net increase.

For investing, this is called crowding out, and it certainly does happen when an economy is running at or near full steam, so that resources (machines, workers, money) are being fully or almost fully utilized, so that all new output of the economy requires new investment dollars. In that situation, private investment competes for those new dollars with government. But when an economy has much slack, as ours does now, so that more money is sitting in money market accounts and short term treasury bills, there is plenty of available money for government borrowing and investing, and still plenty left for any private borrowing and investing the private sector chooses. A similar situation applies to spending -- government spending does not compete so much with private spending during a recession -- concrete prices are down sharply, for instance, so government infrastructure spending on concrete will not be competing much with private demand for concrete to a level that would strain available output.

Objection B) Government spending/investing is top-down, and is thus less informed/knowledgeable than private spending/investing -- less effective at producing the goods and services people actually want for their lives and standard of living.

Example -- Joe would rather buy a new car instead of paying more taxes (or having future taxes) for more city bus service.

This again, as above, is true during a time of economic expansion, but is it true during a time of recession? Currently consumers who have jobs have sharply pulled back in spending, and are saving on the whole, which of course has led to a sharp drop in consumer demand, and thus more and more job losses. Consumers are choosing that they don't want as many consumer goods and prefer instead to pay off their credit cards, or build up their emergency fund.

As they save, more money is available for investing also, and some of it flows into safe US Treasuries. When the Government spends more now, it is not removing money from current consumer spending.


Ok, now let's consider the Obama Middle Class Tax Cut (MCTC) as a stimulus....

We know that tax rebates of a size like that of summer 2008 are much smaller than average consumer credit card debt, and it's little surprise that much of that rebate was saved (or paid against debt), and yet helped the economy in a dramatic way not widely understood. (see link)

We can surmise that much of the coming MCTC will also be saved, at least for a while.

Until when?

Well, that's an individual level decision.

For someone who's been paying off credit card debt for example, they may continue paying it off at the same rate, or even add in the extra take-home pay from the tax cut and make even larger payments (saving all the tax cut). Until....

Until they have paid off the credit cards to zero.

Then what happens?

If you could imagine celebrating upon paying off a card or the last card, I bet you are like most people.

Might you go out to eat? Might you finally get your car repaired? Might you stop putting off that gym membership?

Yes, when consumers have less debt, they will respond by spending more, resulting in more jobs. Some will spend more, some less, but overall spending will increase in response to debt going down (or savings up). Poorer families will spend more, and the sad truth is many "middle class" families are practically poor.

Even while consumers spend less in 2009 with the new tax cut than they did in 2008, the issue is how much less. A tax cut will make a difference in consumer spending, immediately and progressively, both. Many jobs will be saved, adding to the positive effect of those newly created.

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