President-elect Barack Obama and congressional Democrats are crafting a plan to offer about $300 billion of tax cuts to individuals and businesses, a move aimed at attracting Republican support for an economic-stimulus package and prodding companies to create jobs. The size of the proposed tax cuts -- which would account for about 40% of a stimulus package that could reach $775 billion over two years -- is greater than many on both sides of the aisle in Congress had anticipated. It may make it easier to win over Republicans who have stressed that any initiative should rely more heavily on tax cuts rather than spending.
Will this appeal to a bipartisan approach going to reduce the effectiveness of the fiscal stimulus? I have made this argument:
If one is a believer of propositions such as the life cycle model of consumption or the Barro-Ricardo equivalence proposition, one would dismiss out of hand this notion that we can accelerate aggregate demand by passing a tax cut today that will one day have to be financed by a tax surcharge.
But this is weird:
Economists of all political stripes widely agree the checks sent out last spring were ineffective in stemming the economic slide, partly because many strapped consumers paid bills or saved the cash rather than spend it.
HUH? If “strapped consumers” means those facing borrowing constraints, it is precisely these households that are more likely to consume rather than save a tax cut.
Update: Mark Thoma weighs in on this issue and provides us another story by Peter Baker and Carl Hulse that notes:
The legislation Mr. Obama is developing with Congressional Democrats will devote about 40 percent of the cost to tax cuts, including his centerpiece campaign promise to provide credits up to $500 for most workers, costing roughly $150 billion. The package will also include more than $100 billion in tax incentives for businesses to create jobs and invest in equipment or factories.
So only half of the tax cut will go to borrowing constrained households with the rest being given to corporations who are not likely to invest anything extra during this period of weak aggregate demand. Ahem!