Rebates will run up the deficit in a futile attempt at stabilization.
President Bush and House Speaker Nancy Pelosi have, sadly, come to agreement on a completely backward economic stimulus package. Among other things, the plan includes a tax rebate or credit of up to $1,200 for each family with an annual income under $150,000, and a temporary cut in taxes on business investment.
Most of this makes no economic sense.
The rationale for extending tax rebates and credits to middle class families is to increase their demand for goods and services, but it would all be financed by an equivalent increase in the federal deficit. Worse, as Alan Auerbach of the University of California at Berkeley concludes, it would have no significant effect.
As has been characteristic of almost all prior examples of temporary fiscal stimulus, any effects on the behavior of the recipients will be delayed until after the economy has already started to recover. The IRS recently announced that the volume of 2007 tax returns would prevent it from mailing checks out any earlier than June, by which time the economy will probably be righting itself.
The temporary reduction of taxes on business investment would probably increase such investment by a small amount, but mostly by pulling forward investments that would otherwise be made later.
Fiscal policy should not be used in the futile attempt to stabilize the economy. The Federal Reserve's monetary policy is far more effective at this task, and the large recent reduction in the fed funds rate illustrates that it can respond more quickly and more forcefully than any change in fiscal policy.
In general, government policy should be judged by its effects on the incentives to work, save, invest, and increase productivity and output. This fiscal stimulus package would do almost none of the above.
Politicians, in election years especially, feel compelled to be seen as doing something in response to the general concerns of their favored constituencies. Mr. Bush's and Ms. Pelosi's fleeting moment of bipartisan agreement might look good on TV, but it's still an economic mistake.