Here’s a thought experiment: how much money would the government have to dole out to consumers and businesses to reverse the Richard Koo-posited motivation to save in order to repair balance sheets? Write your answer here ___________________.
To begin, let’s assume the already planned Fed and Treasury programs to support the financial system, further increased to match the $6 trillion figure Bill Gross (PIMCO) thinks will be required. That should be enough to repair the banks balance sheets — to prepare them to respond to growing demand for credit.
Now replace the $.787 trillion HR1 stimulus bill with a $1 trillion tax cut. Would the private sector still focus on repaying debt? If that’s not enough, how big does the tax cut need to be? That hypothetical $1 trillion cut is about equal to the total individual federal income tax paid in 2006.
My hypothesis is that the same magnitudes of government deficit instead injected directly into the after tax bottom lines of consumers and businesses will accelerate the balance sheet healing more quickly than inefficient back-loaded spending on projects favored by politicians. It is a question of scale — how far do we have to turn the knob for consumers to feel secure that their savings are back in balance and they can safely spend for say durable goods?
Yes, temporary and small tax rebates are likely to be saved (towards balance sheet repair). The cash benefit of the tax reductions will more rapidly bring the private sector back to a posture of spending, investing and risk taking. The dynamic effects of permanent cuts in marginal rates of the payroll tax, capital gains tax and double taxation of dividends are all very positive for incentives to invest and work. The negative dynamics such as anticipated future tax increases are a constant for any given level of government deficit spending.
How consumers discount to the present the value future tax cuts I do not know. Most business I would expect to do a normal PV with a haircut for the political risk of inconstant politicians.
I think another dynamic effect could be engineered by supercharging demand for equities — i.e., boosting the stock market. As I wrote in that earlier post.
I have a surefire plan to both help the banks and turn the economy around. Give the stock market a big boost. How? Easy, eliminate the capital gains tax, the dividend tax and cut the corporate tax rate.
Why does the stock market matter? Because higher share prices automatically deleverage banks or companies. Citigroup has much bigger loss reserves trading at $20 than at $3. Isn’t deleveraging what we are supposed to be doing?
The same applies to the battered consumer. Doubling everyone’s 401K is a big improvement to their debt/equity ratio. And do you think much fatter 401Ks will REDUCE consumer spending?
Full disclosure: we own more equities than we probably should. Being fully retired, I can attest that we would change our spending behavior dramatically if we were convinced that equities would revert to the trend of earnings growth in the next couple of years. With current policies we think it could be 5 to 10 years to achieve a mean reversion.
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