Bryan Caplan  

Smart Stimulus, II: The Healy Grant

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Black Swans... How You Think in a Crisis...
Here's another clever stimulus idea.  The source is Andrew Healy, who explained it to me over pizza right the day before Christmas.  I'm not sure if he actually advocates it, but here it is:

The federal government temporarily picks up the tab for state sales taxes (or possibly more), as long as the states temporarily stop collecting sales tax.  For example, right now California charges an 8.75% sales tax.  Under the Healy hypothetical, the feds give California a grant equal to 100% (or possibly more) of .0875 times California's taxable receipts.  The state of California then stops collecting sales tax. 

At first glance, this looks about the same as a temporary federal income tax cut.  But in a world with inflexible prices and wages, intertemporal substitution ramps up the effect of a sales tax cut, but not an income tax cut.  What's the difference?  When sales taxes are temporarily low, people have an incentive to buy more now.  With inflexible prices, this intertemporal substitution diminishes the surplus in the goods market.  Income tax cuts, in contrast, encourage people to work more now - exacerbating the surplus in the labor market.

In the long-run, of course, Healy's proposal encourages higher state sales taxes.  Why not have a sales tax of 100% if you know DC is paying?  But as a stimulus package, it has a major advantage over an income tax cut.  Your thoughts?


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COMMENTS (16 to date)
Gary Rogers writes:

I see a moral hazard here. I live in Indiana where we have a AAA bond rating, money in the bank and a lower tax rate than surrounding states. I have nothing against Michigan, Ohio and Illinois but our ability to attract new business to Indiana is based largely on our past fiscal responsibility and ability to offer low tax rates. Taking this away removes an important economic signal.

Lord writes:

Sales tax tends to select for imported goods though.

OneEyedMan writes:

This would single out the states with higher taxes for a reward and punish the ones that depend on income taxe.

Do we really want to encourage consumption? If Americans don't save enough how do we get there by subsidizing consumption?

Marcus writes:
When sales taxes are temporarily low, people have an incentive to buy more now.

But won't those purchases just be another form of savings? In other words, instead of putting money in a bank account, people may save in the form of purchasing durable goods they know they'll need.

But manufacturers will certainly see right through that. If I buy two cases of toilet paper today that's a case I won't be buying a few months from now.

As to non-durable goods and services, it presumes that people are not buying because of price. Yet, it's my understanding that people are not buying out of concern for the future. Eliminating sales taxes simply increases the amount of money they can save.

Not that I think that's a bad thing mind you.

Patrick writes:

Bryan - your libertarian credentials should be revoked. I don't want the government encouraging behavior of any kind....

John writes:

Howabout the government allows you to deduct the cost of all your purchases of consumer goods and services from your taxable income? That would draw a lot of cash out of the money markets of the wealthy and into the economy (as opposed to the govt).

Adam writes:
your libertarian credentials should be revoked

I don't think libertarian credentials can, by definition, be revoked. That's kind of like losing an anarchy license. :-)

Larry writes:

This idea has been discussed a fair amount already, and makes sense on these
grounds:

1) It helps state/local gvt maintain programs that already passed whatever legislative filters are in place, preserving jobs and the spending that follows from them.

2) It encourages consumers to spend now, and what we face in part is a too-rapid deleveraging by households.

3) Consumers get more for their money, raising their living standards.

Dr. T writes:

I live in Tennessee, a state with no income tax and a sales tax rate of 9.25%, the highest in the nation. It seems as if we Tennesseans would benefit greatly from no sales tax, but that is not true. Each summer, just before school starts, we have a sales tax-free weekend (F-S-S) (big ticket items like cars are still taxed). Stores typically prepare for these three days by raising prices 10-20%.

I believe that temporarily eliminating sales taxes will increase retailer profits while providing no savings to consumers.

D. Sean writes:

It seems to me that all the answers to the recession amount to tricking people into spending more. What I can't understand, and maybe it takes a Master's or PhD in economics, is why Keynes and policymakers don't want consumers to do what comes natural. If a person is in debt, loosing money on the stock market and/or at risk of losing their job, why wouldn't they save more. To do otherwise could be destructive in the long-run. But wait, all we care about is shoring up the short run recession. So instead, we worry about the 'pardox of thrift' and scream "spend, spend, spend."

If we think our free-market economy, based as it is on personal decisions like saving when times are tight, is flawed then maybe we should consider a different system. This clearly isn't the case, free markets have proven to be the best system, but we sure act scared of them. Maybe it's about time to trust in the system we all along thought was best, and let the markets correct themselves. That's why I favor cutting taxes permanently, balancing the budget sooner rather than later, and letting the markets show Americans why their credit binge is bad for them.

I'm open to listening to anyone who can answer why a person facing the problems presented above, wouldn't consume less and begin to save more. For that matter, why they shouldn't do so. Even if public spending pulls us out of recession, how will this help us in the long run?

Carl The EconGuy writes:

Here's a more efficient way to kickstart economic activity:

1. Incentivize investments by providing tax credits and accelerated write-offs for all new non-real estate investments for a five-year period;
2. Incentivize hiring and consumption by announcing a five-year moratorium on all social security tax collections;
3. Extend income tax deductibility to all consumer loans, inluding Hummers (that's a good one!).

But I think we can all agree that reducing tax collections works faster than the standard multiplier-based Keynesian govt expenditure schemes which will take months and months to enact and execute before any more money flows out of the govt. And either way, lower taxes or more outlays, we're talking deficit financing here.

Anyway, I really enjoy thinking leisurely about how the heavy, dead hand of government can chase after the invisible hand. It's never worked very well in the past, why should it work now? But it's fun pretending, isn't it? Oh!Bummer's spending program will be full of snakeoil, leaches, and voodoo. The only thing real about it will be the pork, the best $800 billion pork Congress can think up. Yaay! That'll get us going again, don't you think?

The Snob writes:

D. Sean:

The puckish answer would be, "it's hard to pay down debt when you don't have a job." If everybody slows their consumption down, business incomes fall, leading to layoffs, etc. ad infinitum. The bone of contention of course is what the "optimal" level of balance between debt reduction and consumption stimulus might be.

D. Sean writes:

To The Snob:

Thanks for your reponse. You assume, however, that the worst thing is for people to lose jobs and for the economy to go into recession. I'm not saying to forget the unemployed, or even that realistically we will do nothing, all I'm saying is that we should unleash the power of market forces, and government cannot do that.


Here's a great paper by the Mercatus Institute at George Mason University: http://www.mercatus.org/uploadedFiles/Mercatus/Publications/Main_Street_Economic_Recovery_Proposal(1).pdf.

It basically answers the questions from my earlier post and proposes that the cause of the recession was excessive consumer credit and artificially inflated housing prices. Its conclusion: let the market re-adjust itself and fix the source of these price distortions (government deficits, government debt, and high taxes). Now the chances of this happening are very slim, especially since most economists favor some sort of gov't spending stimulus. I like the Mercatus proposal. I may be young and naive, but isn't anyone an idealist anymore.

Bill Woolsey writes:

In aggregate, people should only "save," that is, reduce spending on consumer goods and services, if this is necessary to free up resources for the production of capital goods. Which, by the way,
allows increased production of consumer goods in the future.

The notion that everyone should cut consumption to pay down debts, makes little sense. Paying
down debts means those who lent the money are repaid. Why shouldn't those being repaid spend more on consumption? (Maybe Americans should pay down their debts, and the Chinese spend more on
consumption.)

The notion that reduced employment and output somehow helps the situation is truly incoherent. Less production is less income, and so, a reduced ability to repay debts.

Now, if firms want to invest--purchase more capital goods, that would be great. And it would be important that people save to free up resources
to produce the capital goods.

But the notion that current productive resources
should not be used for anything, when the owners of those resources would prefer consumer goods,
is crazy.

The fundamental economic problem is that there are not enough resources to produce all the consumer goods and services people could use to acheive their goals. Money and credit are about helping to make sure that the most valuable consumer goods are produced at the right time. The cost of one good is the value of the other goods that must be sacrificed to produce it. Losses occur when good produced is less valuable than the other goods become sacrified.

Understand these basic economic concepts. Consider that there are buyers for every seller, lenders for every borrower,etc. You can begin
to see reduced employment and production to repay
debts just doesn't add up.

This is not to say that having the Federal government compensate states for reducing
their sales taxes is the right approach.


Mr. Econotarian writes:

To avoid the moral hazard problem of rewarding states for raising sales tax rates, the Federal Government could instead provide states the equivalent of 4% of sales tax to reduce their existing sales tax by 4%.

(Alaska and Delaware have no sales tax, but all other states have 4% or higher. Perhaps Alaska and Delaware would get 4% equivalent as well but not have to reduce their non-existent tax.)

I still lean towards the payroll tax cuts. There is only a surplus of labor now because of the cost of employing labor. Cut that 6% to 12% and the surplus of labor would be lowered rapidly.

Chris writes:

Better yet, only eliminate the sales tax in half of the states so that we can measure the impacts.

The left typically assumes that taxes are free (unless of course its for stimulus then there is a positive effect).

It would be neat to get the government to supply the empirical means to prove it one way or another.

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