‘Tax Rebate’ Checks Expected to Yield Short-Term Benefits

By Beacon Staff

Recently, Uncle Sam began depositing money directly into the checking accounts of some 130 million American households. Probably $600 for a single person, maybe $1,200 for a couple – maybe less, or maybe more, depending on family circumstances.

Washington hopes recipients will spend much of it, and revive the flagging economy. Most economists expect the $152 billion stimulus package will boost economic activity for several months. They debate the degree of stimulation.

“There is going to be an impact,” says Brian Bethune, an economist with Global Insight, an economic consulting firm in Waltham, Mass. But it will be “muted … not strong or explosive.” High oil prices will hurt the economy, and by 2009, Global Insight predicts the economy will slip perilously close to zero growth.

Lacy Hunt, an economist with Hoisington Investment Management Co. in Austin, Texas, is even less cheery. “It’s a one-shot deal,” he says. “At best, it will lift the economy for a little while.”

Budget expert Stan Collender doesn’t even like the “tax rebate” terminology used by Washington, since many of the poorer recipients will have paid no 2007 federal income tax or amounts less than their government check. The stimulus package, he says, is really “pure borrowing … just increasing the [federal] deficit.”

For lawmakers, passage of the stimulus package in February offered Democrats and Republicans alike the merits of showing voters they are taking action on the economy. For the White House and Congress, it was the equivalent of the Monopoly “Get Out of Jail Free” card, maintains Mr. Collender, managing director of Qorvis Communications in Washington.

The stimulus package is equivalent to 1.1 percent of fiscal 2008 gross domestic product (GDP), the nation’s total output of goods and services. Some $107 billion goes to households, $45 billion to businesses – mostly by giving them a bonus depreciation to deduct from their tax burden.

Global Insight assumes 20 percent of the rebate amounts will be spent within three months, 40 percent within six months, and 50 percent within a year.

Looking at academic research on the impact of the 2001 tax rebates, Hunt predicts only about 25 percent of the new stimulus package will be spent. The remainder will be used to reduce debt or increase savings. Moreover, since lower-income families spend half their budgets on lower-priced imports, the actual stimulus to US economy will be a mere one-eighth of 1 percent of GDP. “There is no evidence historically that [rebates] did anything,” Hunt says. “I don’t think rebates were a good idea.”

In addition, since the federal government must borrow the stimulus money from a limited pool of US capital, there will be less money available for business, states, and municipalities to borrow. And they will have to pay a higher interest rate.

Neither Bethune nor Hunt sound chipper on the economy. Global Insight sees recession in the first half of this year, then a small bounce, followed by more weakness in early 2009, without a “sustainable recovery” until mid-2009.

Hunt talks of “at least another two years of minimal growth.”

If either forecast proves accurate, the next president and Congress will not only face the question of what to do in Iraq but what to do further about a lagging economy.

It won’t be easy.

The Federal Reserve has moved dramatically to keep the economy going with interest-rate cuts and financial support activities to ease the liquidity squeeze. As a result, the economy’s money supply has grown at a 13 percent annual rate over the past three months. If that growth rate lasts much longer, economists’ fears of inflation will escalate. Too much money boosts prices.

But even this growth has been “more than entirely neutralized” by a dramatic decline in the velocity of money, that is, how often the money is spent, says Hunt. It sits unused in financial accounts as banks and other financial institutions try to rebuild capital after suffering severe losses from subprime mortgages, collateralized debt obligations, and other fancy financial instruments. In the current massive credit crunch, velocity has declined at a 2.3 percent per annum rate, calculates Hunt. So the Fed’s “best efforts are likely to be thwarted,” Hunt says.

Adding to the problem, consumers are in poor shape. Assuming house prices drop “only” 30 percent from their peak and stock prices rise just 10 percent from the first quarter level, Americans’ loss in real wealth will amount to about $7 trillion, says Hunt. When wealth declines, research shows, consumers spend less. It could be “a drag” on the economy for the next three years.

If that holds true, President Obama, President Clinton, or President McCain will face larger economic challenges than they may have bargained for.

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