Thursday, August 7, 2008

Feldstein on the Tax Rebate – Life-cycle Model Vindicated

When President Bush and some in Congress thought that their one-time tax rebate was just the right fiscal remedy for an economy about to enter a Keynesian slowdown, some of us wonder if Albert Ando and Franco Modigliani’s old life cycle model of consumption had it right – that people would save much of this one-time tax rebate. Martin Feldstein argues that they were correct:

Tax rebates of $78 billion arrived in the second quarter of the year. The government's recent GDP figures show that the level of consumer outlays only rose by an extra $12 billion, or 15% of the lost revenue. The rest went into savings, including the paydown of debt.

That’s right – very little bang for the buck. Feldstein takes this evidence and then turns on one of Obama’s proposals:

These conclusions are significant for evaluating the likely impact of Barack Obama's recent proposal to distribute $1,000 rebate checks to low- and middle-income workers at an estimated cost of approximately $65 billion. His plan, to finance those rebates with an extra tax on oil companies, would reduce investment in refining and exploration, keeping oil prices higher than they would otherwise be … All of the evidence on one-time tax rebates implies that the Obama plan to send $1,000 rebate checks would do little to raise consumer spending and stop the decline in employment. If the past is an indicator of what would happen, the $65 billion he proposes to spend on this plan would raise consumer spending by only about $10 billion, or less than one-tenth of 1% of GDP.

If Obama’s proposal was solely to boost consumption demand – it is even worse than this as it is a transfer of income from one household to another with the likely effect on aggregate consumption being zero if the households had similar marginal propensities to consume. But a lack of consumption is not what ails the US economy. Furthermore, Obama’s proposal is more designed to address income inequality and less about Keynesian demand stimulus. The fiscal stimulus part of the Obama plan would be from accelerating certain forms of public investment.

Feldstein closes on what I consider heresy:

The distinction between one-time tax rebates and permanent changes in net income is also important for the debate about Mr. Obama's proposal to raise income and payroll taxes. Because those tax increases would be permanent, they would cause a substantial reduction in consumer spending and aggregate demand.

Feldstein is well aware that we have a long-term fiscal imbalance with the current level of taxes being far below the current and projected level of government spending. Ricardian Equivalence types would mock at the idea that recognizing those deferred taxes into current taxes might curb aggregate demand. And even if one rejects Ricardian Equivalence, how can any economists with a supply-side orientation dismiss fiscal responsibility. After all, Keynesian maladies tend to be short-run affairs but the crowding-out of investment is something that lowers long-term growth. Feldstein knows this and usually preaches this. What on earth got him to close his WSJ oped with such heresy?

Update: Mark Thoma is linking to several comments about this Feldstein oped including how Free Exchange has caught Feldstein criticizing something he once endorsed:

MARTIN FELDSTEIN wrote back in December of 2007 that a fiscal stimulus was needed, and that a good way to design said stimulus was in the form of uniform tax rebates. For once, Congress did just what an economist wanted it to do, introducing a tax rebate stimulus plan that sent cheques to millions of households in the second quarter of this year. Naturally Mr Feldstein is appreciative, no? No. In today's Wall Street Journal, Mr Feldstein writes that of course the stimulus didn't work, and what's more, any old fool should have known it wouldn't. I believe this is what is known as a flip-flop.


BruceMcF said...

It does seem reasonably clear that Martin Feldstein's operating procedure here is conclude first, create argument after.

Cherry-picking policy points, Martin Feldstein argues that a windfall profits tax will discourage investment. However, the reality is that with roughly 25% of world consumption, 8% of world production and 2% of world reserves, the big gains to be made in the US are in improving efficiency of consumption and shifting where possible from consuming crude-oil based commodities to harvesting sustainable, renewable energy sources.

And since pursuit of those two tracks have the biggest leverage in the global oil market, they are the best policy for moderating expectations of future oil prices.

And the lower the expected future price of oil, the lower the User Cost from foregone capital gains from exploiting oil leases already held.

However, those implications of Obama's Energy Economy policy being inconvenient for Martin Feldstein's conclusion, they are simply passed by.

Indeed, a genuine windfall profits tax would, if the windfall profit threshold is set high enough, would have a similar impact in reducing the User Cost of foregone capital gain by reducing the share of the capital gain on oil price increases that is retained by the oil company.

Further, on Feldstein's own reasoning, a recurrent $1,000 energy adjustment rebate will lead to more stimulus than a one-off stimulus check. said...

Of all the economists who regularly get touted as candidates for the Nobel Prize, I must say that I find Feldstein to be among the least deserving. His supposedly greatest work has been all this repeated drivel about how social security is responsible for declining US savings rate. Of course, the savings rate fell in response to the original Reagan tax cuts prior to the Greenspan Commission's actions to raise the fica tax and the retirement age. His work is the foundation for the long running assault on social security that we have seen become so well organized. He has been able to push this from his position of power as head of the NBER. Bah humbug.

Ken Houghton said...

Geez, Barkley, you sound like me on a good day. Next thing you know, you'll be quoting Feldstein's "it's an accounting identity" to explain that the precipitous decline of the US dollar (and concommitant effective domestic inflation), which just happened to coincide with the 1986 Rape of the US Consumer, was inevitable, not political manipulation.

But seriously, how do you really feel?