Opinion: Why tax cuts would have been better than govt spending sprees

By Neville Bennett According to CNBC, the "cash-for-clunkers" program cost the US tax payer US$24,000 per car. Still, along with the stimulus, it helped to convince many people that the US is out of recession. As a contrarian, I believe the GDP figures were horrible. Moreover, there are increasing doubts about the stimulus: recent research shows that a dollar spent does not create a dollar's worth of activity, but only 60cents-80 cents worth. I suggest it would have been more cost -effective to grant an income-tax holiday. GDP Data Most media failed to explain that the US economy grew by 0.9%. It reported the annualized figure of 3.4%; a figure which will be achieved if subsequent quarters are equally positive. They may not be because this quarter incorporated some one-off increases. The largest was a 22% increase in consumer durables, which was largely the clunkers, not consumer whiteware etc. A rise in home construction was the result of tax credits for first home buyers. Much of the rest was money from helicopters. US consumer confidence is at a 26-year low: reflecting massive unemployment and other untoward patterns. Imports exceeded exports, government expenditure increased by 8%, private industry decreased inventory. Real personal disposable income fell by 3.4% and savings fell as the cars and houses purchases increased debt. Any detailed reading becomes quite gloomy. The market realized this when it received an update on consumer sentiment. The Conference Board reported an index figure fall of 53.5 to 47.7. Economists had predicted stability or growth, not this large fall. An index of 90 is needed before real growth can occur. GDP rose because of exceptional spending and its rise seems a poor return for the massive stimulus expenditure. The US Government has spent about $10,000 per person. The next quarter could return negative figures. Ongoing Destruction As I write, the failure of CIT as been announced. This follows the failure of 100+ other banks this year. The housing deleveraging has hurt many banks world-wide, but the cancer is still spreading in huge write -offs of commercial mortgages and company loans. These write offs have erased about 10 years worth of banking profits. Unfortunately, the banks have not been able to rebuild their capital sufficiently to feel secure in lending. Many authorities believe it will take many years before lending reaches pre-crisis levels. This view is supported by declining world trade and a shrinking world economy. The world economy is projected to decline by 2.3% this year. As the trend has been a positive 2% growth, the loss is enormous (about US$ 2 tr). At a time when governments are pumping billions into the economy, the EU has declared that, for the first time on record, bank lending to business and households has fallen. This is an impediment to recovery. China's exports are down over 15% on September 2008. The OECD reports that the jobless rate in the OECD was 8.6% and predicts 10% next year. The crisis has put limits on future growth. Over the next few years government debt will be a call upon the budget. In the UK's example, debt servicing in 2014 is expects to equal the present education budget. As the IMF's World Economic Outlook emphasizes, recessions that are caused by financial crises are twice as severe as ones from other causes. output is permanently impaired and 10% below trend for 7 years. The British Treasury accepts that 5% of UK output is lost permanently. Stimulus:Effective? The "Greater Depression' has created debate on policy to smooth out fluctuations in the business cycle. Some governments gave taxpayers money, some cut taxes, all of them increased purchases of goods and services to replace falling private demand. The assumption is that the multiplier is greater than 1: that is, the economy's output will grow more than government purchases. Some empirical research by Robert Barro and Charles Redlick cover many years of US history and studied defense spending in particular. It concluded that the multiplier falls in the range of 0.6 and 0.8. They express doubts "that non-defense multipliers are larger". Granted that some stimulus was needed in the 2008 panic. Were there alternatives? Barro and Relink opt for tax cuts as preferable, as" a one percent point decrease in the average marginal tax rate (leads) to about 0.6% in the growth rates of real per capita GDP". This is a very exciting finding. While there may be a good rationale for funding some projects with excellent long- term benefits, it is probable that others have dubious returns. In the New Zealand context I favour a national cycleway, but regard some roading as equivalent to the wasteful funeral projects of the pharaohs: I would prefer the private sector bear the risk through toll roads, and apply user-pays principles rather than load our children with debt. Job Destruction The standard advice to middle class people at present is to extend their working life as savings and house values have shrunk. But in the US, where this advice seems very pertinent because it has had the hardest housing hit, there has been a rush to retirement. Why? The reason is that it is rational to retire. Most older households have few investments; the median stock assets for households aged 55 to 64 is US$8,000. The research suggests that only higher educated workers in their 60's respond to stock market fluctuations. Houses are more important as 81% of households aged 55-64 own homes with a median equity of US$140,000. Courtney Coile and Phillip Devine found no evidence that workers responded to changes in house prices. But people in their sixties, especially those with low education, are responsive to the labour market: they accept retirement. They throw in the sponge, and rather than job seek and receive benefits from Unemployment Insurance, prefer to accept Social Security. The labour market (unemployment) is much more important than stock market wealth. The average US elderly person feels forced into retirement to make ends meet, resulting in lower income in later years and increased poverty in old age. * Neville Bennett was a long-time Senior Lecturer in History at the University of Canterbury, where he taught since 1971. His focus is economic history and markets. He is also a columnist for the NBR where a version of this item first appeared. neville@bennetteconomics.com www.bennetteconomics.com