US Stimulus Tax Cut Thoughts Part II

The individual tax cuts would essentially be a repeat of last year’s stimulus package. True, it didn’t stave off the recession, but it did provide at least one quarter of solid growth last year. The exact amount of last year’s rebate that was actually spent is not known, but most estimates are that between 30-40% was spent, and the rest was either saved or used to pay down bills.

Money that the consumers save is not going to stimulate the economy. However, an individual stimulus still might be worth doing, even in an environment where the Federal budget deficit is out of control.

Why?  Let’s try this thought experiment: Suppose that every last dollar of the rebates was used to pay down debt. In essence, the taxpayer would be transferring debt from one pocket to the other. The government is going to be borrowing to get the funds to pay these rebates, so the taxpayer will have to pay that back later through higher taxes (or the hidden tax of inflation), or enjoy fewer government services in the future.

On the other hand, he now has a better personal balance sheet since he paid down his personal debt. However, if he is paying down 18% credit card bills and the government is paying less than 3% for its debt, there is a huge interest rate arbitrage gain. Banks wouldn’t particularly like that outcome, since lower credit balances mean less ability to suck the life blood out of cardholders.

Then again, balances that are paid down are balances that don’t default. Net-net it would be a negative, though, for the big credit card companies like Capital One (NYSE:COF) and Bank of America (NYSE:BAC).

Now that is an extreme example, but one of the core problems the country has is that people in the bottom 90% of the income distribution simply don’t have enough money. Incomes have been essentially flat in real terms for a decade. They have too much debt and not enough savings. A check for $1,000 would help to pay the mortgage and the utility bills, and maybe, just maybe, prevent a few foreclosures at the margin. The multiplier effect of the tax cuts will not be as big as for infrastructure spending, but that does not mean they are not worthwhile.

I’m not sure that the stimulus package is big enough to really turn the economy around, and the government is already running a huge deficit (CBO estimates it at $1.2 Trillion before the stimulus package) which constrains the ability to make it bigger.

However, the individual tax cuts could be like an air bag. The car might still get totaled, but at least the passengers can walk away with only minor injuries.

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