September 1, 2009

The Right Way to Structure Cash For Clunkers and Other Incentives

I should have written this post back when I first had the thought a month or two ago.

Any buyer-incentive program from the Federal Government will work much better for the market, buyers, and businesses, and for the general economy, if it attenuates gradually over time.

So for example, in the Cash for Clunkers program, the correct structure would be:

A) Begin with a more modest rebate, which would be used more slowly; and

B) Attenuate the rebate gradually.

Why attenuate gradually?

The program as structured, with a huge incentive, will pull forward in time sales that would have happened in the next year or two, and thus will rob sales from the future. But it won't last long enough on the other hand to build strong economic momentum.

Instead of this structure that fails to create real economic momentum -- we could instead accomplish actual economic stimulus with simply a better structure.

Specifically, for Cash for Clunkers, the maximum rebate should have operated as follows:

$2500 (instead of $4500), set to last until an initial $1bn is used up, and then stepping down to $1500 for an additional $1bn, and finally, to $1000 which would be set to last for a defined period of time of 3-5 months.

The effect is to stretch out the program, and sustain the increase in sales, so that economic momentum begins to build over time through secondary economic effects.

It is not too late to fix the mistaken structure of Cash for Clunkers.

The correct continuation should be to offer another $1bn in Cash for Clunkers Part II at a lower level, such as $1500, followed by a final a final level of $1000 that should last a defined time period, such as 4 months.

This could be done now.

This same principle should be used for any kind of buyer-incentive stimulus program, such as the First-Time Homebuyer Credit.

Consider this sequence: First, in 2008, was a $7500 credit which was a %0 interest, 15-yr loan, which must be paid back; Next followed a simple grant in 2009 for $8000. (Remember how the 2009 "credit" was initially proposed to be an over-the-top $15000? The proposal for a $15,000 credit showed a lack of common, middle-class sense.)

So instead of attenuation we had the opposite. If you bought or sold a home in 2008 during the first incentive program, you got cheated in a sense -- you have to pay back your credit, but you also have to help foot the tax bill for the far better "credit" in 2009 other home-buyers will receive.

If you buy or sell your home after this second program ends, you get cheated since you will help pay the taxpayer cost of the 2009 credit but receive no credit yourself. (update -- an extension of the credit at a new grant level of $6500 until April 2010 was created a couple of months after this post was written.)

The program as it is now is bringing future home buyers forward in time, and when the current program ends....we will see dropping sales. The market will not have bottomed -- the temporary uptick now from the 2009 credit will suddenly disappear.

The program should have started with a grant open to all homestead home buyers, and be set to attenuate gradually, lasting through 2011 or 2012.

Again, it is possible to fix the bad structure we have now.

The correct structure now would be to extend the program as a $4000 credit for 2010 (or December 2009-December 2010), and include *all* homestead home buyers (who live in the home they buy) for fairness, followed by a $2500 credit for 2011 and a $1500 credit for 2012.

This would have an effect of actually helping the housing market to bottom out, which will take considerable time, and being more equitable to buyers of homes in 2010-2012.

Economic momentum from the program could build, and the effect of simply bringing sales forward in time would be greatly reduced.


What is striking about the these existing programs is how they could have been improved by soliciting and taking advice from an experienced business person who has a broad outlook.

Congressional staffs working on such legislation should invariably hire outside help from someone who has managed a small business and who has long experience and can talk about what will work for the middle class customer (there are thousands, tens of thousands of successful small business people who could and would offer good advice). Such a person would bring a superior, real-world sense of how to actually get the desired result. Such a person knows what it takes to appeal to middle-class families.

For instance, the congressional staff working on legislation could ask:
"If we run this program Cash for Clunkers at $4500 per car for say 250,000-350,000 cars, would that be about right to kickstart some circular effects of auto jobs and people buying cars and some stimulus for the general economy?"

To which the advisor would answer: "A little, but that's a poor structure."

"Why not?"

"Because that is so much money that it will only bring a rush to buy by everyone that is able to buy and wanted to sometime in the next year or two. Then, you have a let down."

"But won't more total buys happen on net, say over 4 years, than would have happened otherwise?"

"A little, yeah. But for the same federal money or a bit more, you could have instead a much larger number of sales over next few years. And that would mean more middle class jobs and a stronger economy."


"Look, if you live in a neighborhood and your neighbor bought a Cash For Clunkers car, and you didn't buy one then you think something like: 'Oh well, I missed out,' and you adjust psychologically, and you go on being the new frugal, as you were already. But....if your neighbor gets a Cash For Clunkers new car with a $2500 or $1500 credit, and in the meantime the $1000 level is still available, you've got weeks to see that new car next door and think about that $1000 that is still available a while longer.... It's an entirely different psychology altogether. An entirely different outcome. More people will decide a new car is the way to go.

"You need something that makes people feel like the next three or four or six months is a good time to buy a car, not that only the next 8 days. You need to spread the money out, make it gradual, like a steady pull. And it has to be well-defined and clear. So that you know that if you miss the $2500 level, you can get the $1500 level. Stuff like that. Like if you miss out on the $2500 or $1500, you can still get a nice $1000 bonus for buying a fuel-efficient car, and that last chance level has to last, like months."

I for one would be glad to help correctly structure such future legislation, which I think may once again be on the table someday, once the current programs are seen to have failed.

While general confidence is the main determinate of whether we will skirt and escape a second great depression, even the recent uptick in confidence isn't yet enough to assure the outcome. As Ambrose Evans-Pritchard points out, the world is still awash in over-capacity. This moment of skirting the edge is not over yet.

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