Thursday, February 12, 2009

The Stimulus Divide

Just about everyone agrees that when the economy is slow, the Government can help by providing a "stimulus." (In fact, agreement on this principle is so widespread that it's probably wrong!)

What the political parties don't agree on is how best to do it. Beginning in 2001, Republicans controlled the White House and Congress. The economy was slow after the "tech bubble" burst. W Bush proposed an economic "stimulus" consisting primarily of cuts in business taxes and lower rates on income taxes. (He also boosted defense spending.)

The good news was that when Bush took office, the government had a surplus, so it could easily afford a temporary stimulus.

Congress gave W what he wanted, but the "stimulus" was hardly temporary: the tax cuts were mostly in place for 8-10 years, and the Government began running large deficits every year of the Bush administration as it tried to pay for the wars in Iraq and Afghanistan without taxing for them. (Most of that stimulus went abroad.)

The 2000-2002 recession was relatively mild, but the recovery was incredibly anemic. Growth never really took off and we were quickly off to the next bubble.

Now we have a deeper economic crisis, but with no surplus in place. Nor do we have as much room on taxes as in 2000 since rates never went back up.

Republicans are attacking Obama's stimulus plan, which is mostly a spending plan, rather than a tax reduction plan. And therein lies the difference between the two parties. Republicans like to stimulate with tax cuts; Democrats like to stimulate with spending increases. Both have their problems.

On the GOP side, "stimulating" with cuts in income tax rates does little for most people because the bottom 50% of the income pile don't pay income taxes. They do, however, pay a significant portion of their wages in payroll taxes--social security and Medicare--along with sales taxes, gas taxes, phone taxes, etc. Not surprisingly, the 2001 tax cuts pushed through by W Bush did little to revive the economy because most of their benefit went to less than 10% of the population.

In the long run, they did more harm than good, leading to large deficits even in relatively "good" (but not great) times.

On the Democratic side, the stimulus spending package has its own problems. It is chock full of political favorites--rural broadband, green energy, road projects, etc. A lot of this would get done anyway, and very little goes to the sector where our problems all started: housing. (We're not saying the gov't should fund housing, since there's a glut on the market.) It takes a Depression-era approach to an economy that bears no resemblance to that of the 1930's (when farming and manufacturing were the dominant economic sectors). Like the GOP stimulus of 2001, the Democratic stimulus is pretty hit or miss--many people won't get any benefit at all from it.

Furthermore, between the stimulus package and the bailout packages, we seem to be on a path of having the government borrow its way out of a mess caused by . . . yep, too much borrowing.

We hope that on the borrowing side the costs of the bailout will prove smaller than expected. If the Government can purchase "toxic" assets and stabilize the market, it may ultimately be able to sell those same assets for as much, or more, than the purchase price. The RTC did it with failed banks in the 1980's. One key is to have a professional group managing the program with minimum political interference.

We will recover, even if the Government does nothing. Or maybe even if it does something. Markets are already starting to correct for the past excesses. Housing prices will stabilize, and eventually more people will need new housing. Likewise, demand for other goods will eventually increase, particularly goods people need, as opposed to those they just want. The pain of those much needed corrections, however, will not disappear overnight.


toronto real estate said...

That's right. When the economy crashes, it means something that was wrong is being corrected. Whether the government does or does not anything, we will still survive. Maybe the standards of living will temporarily change and maybe the way we think will change also, but the bottom like is that we will survive. Thank you for great reading.

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