Told you Laffer wouldn’t be laughing

A few weeks ago, Bush announced that he had agreed with Congress to steal from the rich to give to the poor, quacking, “Stimulus! Stimulus!” This was my reaction:

When US president George W Bush praises Democratic speaker Nancy Pelosi for her leadership, as he did over the “stimulus package” he proposed, you know something bad just happened. When Pelosi beams broadly, and places emphasis on how the measures are “temporary”, you just know she means, “when the election is over, you’ll be paying for it, you gullible fools”. If there’s anything more distasteful than a misguided but principled partisan proposal, it’s a waffly but expensive bi-partisan cop-out.

Yesterday, Arthur Laffer, to whose explanation of how tax works in the real world I referred, wrote this:

Bipartisanship, a notion that stands as anathema to our basic political premise of checks and balances, has resulted in a stimulus package that will do enormous damage to the U.S. economy. [Cut detailed explanation why robbing Peter to pay Paul has zero stimulus effect, but discourages production.] Whenever you observe bipartisan cooperation, hold on to your wallet and run to the basement.

His exposition of the problem of tax rebates, as opposed to tax cuts, as a method of stimulating a sluggish economy, is clear and devastating. I disagree with him on one matter, though, or rather, think he missed a relevant point that leaves his otherwise sound argument open to dispute.

Laffer argues, in essence, that rebates amount to wealth transfers, and in this case were specifically designed to benefit the poor. Inasmuch as someone has to pay for them, this has zero stimulus effect, and has substantial negative effect in terms of disincentivised production on the part of the most productive. So far, entirely agreed.

One effect of a tax rebate that is not accounted for in this explanation, however, is that it brings forwards consumption. The rebates go to people who are more likely to spend it on consumption in the short term, and are taken from people who are more likely to save their money and defer consumption. It is true that the net effect is zero (and the costs make this negative). Instead of sending out $170 billion rebate cheques, you might just as well have ordered taxpayers to spend $170 billion and deduct if from their taxes due. (At least, in the latter case, people would have kept their own hard-earned money.)

The impact of a rebate, therefore, is to borrow from future consumption to stimulate present consumption. This would dampen the effects of today’s downswing in consumption, at the expense of tomorrow’s upswing, and therefore would have an effect. No positive net effect, true, but an effect nonetheless.

Not that such inefficient redistributionist intervention is advisable, of course. By every economic measure, tax cuts are preferable to tax rebates, but ignoring the dampening effect of a shift in consumption timing ignores the key reason Nancy Pelosi grinned so broadly: the “stimulus” is “temporary”, meaning it achieves nothing in the end except redistribution. That sounds like “fiscal responsibility”, because there’s no risk that it will actually make anyone (and heaven forbid, “the rich”) more prosperous in the long term. Such perverse economic logic warms the cockles of any socialist heart.