Why Isn’t the Tax Cut Paid as a Lump-Sum?
Posted on February 20th, 2009 in Economic Stimulus, Taxes |
The Tax Policy Center has a nice breakdown of the tax cuts in the stimulus bill. Not great grades, I must admit. The biggest let-down for me is the “Making Work Pay” tax credit, even though the TPC gives it a B+. Personally, I would have preferred a lump-sum check. Now how am I going to justify that smart phone I was thinking about buying? It turns out that the $400 per individual and $800 per family will be allocated by reducing the amount of withholding on each paycheck over an entire year. According to the TPC, the money is more likely to be spent rather than saved as a result, thus adding to the tax cut’s stimulative effect.
I suppose the reasoning is: if you’re not even noticing the extra $15 you’re receiving in your paycheck, you’ll probably spend it without noticing. On the other hand, if you have some credit card debt or you’re concerned about saving money, a check for $400 will definitely not be spent. And, this may indeed have been what the administration was thinking in spreading the $400 out for the whole year. Here’s an interesting analysis from the New Yorker:
You might think that handing people a big chunk of change is a perfect way to get them to spend it. But it isn’t, because people don’t treat all windfalls as found money. Instead, in the words of the behavioral economist Richard Thaler, people put different windfalls in different “mental accounts,” which in turn influences what they do with the money. Where the money comes from can have a big impact on whether people spend it or save it: casino winnings are more likely to be spent than, say, money from an inheritance. The framing of a windfall is important, too: a recent study by the business professors Nicholas Epley and Ayelet Gneezy showed that when a tax rebate was presented as a bonus it was more likely to be spent than when it was presented as a refund. And the size of the windfall matters a lot: the bigger the windfall the more likely it is to be saved.
I was prepared to spend a lump-sum, but maybe most Americans would have saved that money with the economy so shaky and the danger of unemployment in everyone’s mind. It’s a lot harder to be disciplined enough to save an extra $30 a month than it is to save a single check worth $400.
4 Responses
I agree with the logic that says a small amount of extra money each month/every 2 weeks is more likely to be spent off than a large lump-sum check. After buying a house last year (and then immediately dropping $3400 on a busted water line), my main priority is to rebuild cash savings, so any bonus money that arrives in large chunks ($400 is large to me!) gets thrown straight into savings and not spent.
I still have trouble wrapping my head around the concept that “more spending!” is the key to an economic recovery. It makes sense to me that if no one spends money, businesses go out of business, but on the other hand, Americans have saved almost nothing, ever, for decades, and this is a big problem when unemployment comes knocking. I especially hate that people who have been disciplined and saved up money are being punished for it now with lower interest rates on what used to be high-yielding savings accounts. (My ING Direct interest rate is half of what it was 2 years ago, meaning that whatever I save gives me fewer returns than it used to.)
Congress was right to reject another lump-sum tax refund. As nice as it is to receive that $400 check in the mail, history has since revealed the lump-sum checks were ineffective: government statistics show that only between 10% and 20% of the rebate dollars were spent. The rebates added nearly $80 billion to the permanent national debt but less than $20 billion to consumer spending.
Not that the West Wing is my policy bible (ok, maybe it is) but there’s a fabulous episode where President Bartlet chides Charlie for using his stimulus check to pay down credit card debt: “What, a trip to Banana Republic would have killed you?”
The problem is less whether consumers will save their checks, and more whether they will simply use them to pay off debts. Stimulus initiatives are often judged based on their multiplier effect. Using a tax refund to shore up savings at least still carries a multiplier, since banks can then use that money to make loans. Paying off debts - while sensible from the consumer’s perspective - carries almost no multiplier with it. Economic principles suggest that this problem might well explain a good chunk of the smaller-than-expected stimulus from last time.
Interesting stuff, huh?
Also, when a stimulus tax cut is a lump-sum, it can be confusing for people to know what to do with their stimulus checks. I remember having conversations with people last Spring and we were debating the things that we could buy that would most stimulate the economy. We didn’t want to stimulate China’s economy or Japan’s economy by buying products made by foreign companies. What kinds of businesses should you spend at–large or small? Should you spend in the industries that are most in need of help or would spending in any industry do?
In terms of spending vs. saving, it seems like a classic chicken and egg problem. Solid personal finance would tell us to save so that we won’t be absolutely destitute if something bad happens to us in a rough economy, which is what we’re in. But macroeconomics tells us that we need consumer confidence to increase and spending to increase in order for the economy to grow again. But for consumer confidence to increase, people need to see that the economy is growing again and that unemployment is going down first! I suppose the idea with the stimulus is to spend a billions on projects that will at least stop the bleeding by freezing unemployment growth. That, in turn, will give rise to a slightly greater amount of consumer confidence, which will in turn give rise to less unemployment and so on, and eventually the cycle will lead back to growth. That’s my best shot at understanding the logic of the stimulus plan.
ING used to be such a great way to save and I have saved there for many years too. I guess it’s another great example of the contradiction: what is bad for the individual may possibly be good for the general economy. No more high yield savings accounts may discourage some from saving at all.
LOL I don’t think I’ll be alone in appreciating that West Wing reference, Kira. I admit that I’m like Charlie on this one, and a reflection of those statistics. I wasn’t a very patriotic spender. I used most (80% or more) of my stimulus last spring to pay down some credit card debt. I think I spent the rest on clothes. But any good personal finance adviser would have told me that I did the right thing. So I just did not have a very good self-interested reason to spend all of that money, and based on those stats it sounds like there were many others in my position.