Tax Refunds as Stimulus?

Senior citizens would hoard it, not put it back into the economy.

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This Senior Citizen would.

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The same day the Fed issued its panicked rate cut, transportation giant CSX (NYSE: CSX) issued a strong earnings release. Additionally, that very same day, health and personal care titan Johnson & Johnson (NYSE: JNJ) reported solid earnings and forecasted growth for 2008. The message is clear: Aside from people who borrowed too much to buy homes they couldn't afford and banks that devised too-clever derivative securities to try to pass on the risks, the overall economy is not so horribly off-track.
As a result, the bond market, stock market, currency market, and gold market all did exactly what you would expect, given this backwards Fed policy: They forecast higher inflation and adjusted accordingly.
It's only going to get worse
The participants in the global capital markets realize this far better than the Fed does. The Fed is essentially trying to "push a string" with its panicked rate cuts -- trying to stimulate demand that isn't really sagging outside of housing. For heaven's sake, even the housing bubble behind this banking crisis hasn't completely deflated. Homes have simply become less insanely expensive. Nationwide, houses still cost more than they did in 2004 (link opens a PDF). Unless you're a real estate agent, a house flipper, or a subprime mortgage originator, that's not a crisis -- that's a correction.
In years gone by, aggressive rate cuts helped stimulate the American economy by encouraging domestic investment and spending. That worked wonders when manufacturing and consumption were heavily centered in the United States. These days, however, the rules of the global game have changed. A policy that may have worked years ago will fail in today's globalized economy. As a result of continued Fed missteps, capital is clearly fleeing the U.S. for more lucrative opportunities abroad.
Take advantage of reality
There are now middle-class consumers popping up all over the world. That provides demand that's independent of the U.S. The bailouts for Citigroup and Morgan Stanley came largely from foreign capital. That means there's real money in the rest of the world. And as important, the world's biggest steel maker isn't based in Pittsburgh anymore. Instead, Luxembourg-based Arcelor Mittal (NYSE: MT) holds that title.
Capital. Industry. Consumers. Put them all together, and you have a recipe for a global economy -- one that's set to gain from the missteps of the Fed. That's why, at Motley Fool Global Gains, we believe that every American investor must have exposure to foreign Economies
http://www.fool.com/investing/international/2008/01/23/why-bernanke-was-wrong.aspx?source=ihpdspmra0000001

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Since the Democrat majority in Congress has now approved an economic stimulus plan that is centered around giving cash rebates to taxpayers, i.e., tax cuts, can the Democrats ever again complain about cutting taxes in general for the sake of improving the economy? If the slight tax cut, that the Democrats have approved, will stimulate the economy, wouldn't a larger tax cut stimulate the economy even more? So how much stimulation can the Democrats stand?

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I think the Democrat response (if they were honest) would be that most of the people who will receive rebates don't pay any income tax anyway. Moreover, none of the people in the highest two tax brackets, will receive rebates, nor will most of those in the third (25% rate) bracket.

Except for a relatively small group in the middle, the situatiuon is that those who get "rebates" don't pay taxes and those who pay taxes don't get "rebates".

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georgeob1 wrote:

I think the Democrat response (if they were honest) would be that most of the people who will receive rebates don't pay any income tax anyway. Moreover, none of the people in the highest two tax brackets, will receive rebates, nor will most of those in the third (25% rate) bracket.

Except for a relatively small group in the middle, the situatiuon is that those who get "rebates" don't pay taxes and those who pay taxes don't get "rebates".

If tax rebates/cuts for some of the people in the bottom tax bracket will stimulate the economy, why wouldn't tax rebates/cuts for people in the top two brackets not likewise stimulate the economy?

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Well, the theory is that those with lower incomes are more likely to quickly spend the money - this stimulating demand. The reciprocal of this of course is that, if the others don't spend their rebates and instead save it, the result will be more capiital formation and presumably investment, which should have an even greater beneficial effect on the economy. (Of course none of this works if the government is in deficit, and borrowing the money to pay for the rebates).

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georgeob1 wrote:

Well, the theory is that those with lower incomes are more likely to quickly spend the money - this stimulating demand. The reciprocal of this of course is that, if the others don't spend their rebates and instead save it, the result will be more capiital formation and presumably investment, which should have an even greater beneficial effect on the economy. (Of course none of this works if the government is in deficit, and borrowing the money to pay for the rebates).

Why wouldn't people in the top two tax brackets not invest the money they have due to a tax cut/rebate?

And remember that simply spending tax cut/rebate money when you don't expand the economy's productive capacity will merely cause inflation.

Furthermore, since most of our consumer goods come from other countries, how is spending tax cut/rebate money on the consumer goods that people in the lowest tax bracket are going to buy supposed to stimulate the U.S. economy?

I will give Huckabee credit for saying that if we are going to spend billions trying to stimulate our economy we should spend the money on our infrastructure.

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flaja wrote:

Since the Democrat majority in Congress has now approved an economic stimulus plan that is centered around giving cash rebates to taxpayers, i.e., tax cuts, can the Democrats ever again complain about cutting taxes in general for the sake of improving the economy? If the slight tax cut, that the Democrats have approved, will stimulate the economy, wouldn't a larger tax cut stimulate the economy even more? So how much stimulation can the Democrats stand?

No, depending on where you are on the curve, tax cuts could hurt the economy a little or a lot. From our overall taxation right now, I think the rebates will hurt the economy in the long run even if it heats things up in the short term. It would be far better for the government to pull in some infrastructure projects from 2009 or 2010 than borrow money and give it to people.

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engineer wrote:

No, depending on where you are on the curve, tax cuts could hurt the economy a little or a lot.

Tax cuts on people who invest what they no longer have to pay in taxes will pretty much always improve the economy because investments can increase the economy's future productive capacity while creating jobs.

Tax cuts on (or handouts for) people who simply buy consumer goods will invariably hurt the economy because of inflation. A rich man's tax cut could lead to a new factory. A poor man's tax cut (or handout) will simply drive demand for consumer goods that the economy may not be able to produce.

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From our overall taxation right now, I think the rebates will hurt the economy in the long run even if it heats things up in the short term.

Most of the money will go to either the oil companies or China by way of Wal-Mart and consumer prices will likely go up for everyone in return.

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It would be far better for the government to pull in some infrastructure projects from 2009 or 2010 than borrow money and give it to people.

Something that I've already said in an earlier thread on this topic.

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Absolutely, it's an election-year stunt.

If it has any effect on the economy at all, it will be extremely short-lived. Say, one or two weeks, tops. It will take folks about that long to spend it. This silliness won't solve any of our real economic problems.

But there isn't a politician alive who would vote against it in an election year like this one, regardless of party.

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Eva wrote:

But there isn't a politician alive who would vote against it in an election year like this one, regardless of party.

But there's always politicians like McCain who managed to be too busy campaigning for the White House to actually be in D.C. when the vote was taken.

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flaja wrote:

Tax cuts on people who invest what they no longer have to pay in taxes will pretty much always improve the economy because investments can increase the economy's future productive capacity while creating jobs.

Not necessarily. Once all the capital is available to fund useful projects, any extra just sits there unused or gets used on less desirable projects (see dot com bubble). Right now, the capital markets are flush with money. That also drove the real estate lending bubble. There was so much capital in the market that all worthwhile projects are getting funds.

flaja wrote:

Tax cuts on (or handouts for) people who simply buy consumer goods will invariably hurt the economy because of inflation. A rich man's tax cut could lead to a new factory. A poor man's tax cut (or handout) will simply drive demand for consumer goods that the economy may not be able to produce.

But what if we don't need a new factory? The other question you have to ask is "what would the government do with the money if it had it?" As you mentioned earlier, the country needs new infrastructure, but we don't have the tax dollars to support it.

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engineer wrote:

Not necessarily. Once all the capital is available to fund useful projects, any extra just sits there unused or gets used on less desirable projects (see dot com bubble).

What extra can there be? The laws of supply and demand guarantee that a surplus of investment capital will lead to lower interest rates which will encourage people to borrow thereby eliminating the surplus. And something like the dotcom bubble can have long term benefits. Without that bubble I doubt that the internet would be what it is today because the dotcoms fueled computer sales as well as website/internet R&D.

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Right now, the capital markets are flush with money. That also drove the real estate lending bubble. There was so much capital in the market that all worthwhile projects are getting funds.

And that bubble has gone bust because it was based on bad loans, i.e., mortgages are worth more than the legitimate market value of the properties. This is a failure of regulation, not economics.

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But what if we don't need a new factory?

How would you determine what is and is not needed? When most consumers were satisfied with video cassette tapes no factory was needed to make DVDs, but investment capital allowed people to establish DVD factories. More often than not consumer demand is fueled by what producers can and are willing to produce. Producers create demand for innovated products more often than consumers do. The more money there is to invest the more demand can be created and the more the economy can expand.

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The other question you have to ask is "what would the government do with the money if it had it?" As you mentioned earlier, the country needs new infrastructure, but we don't have the tax dollars to support it.

We certainly don't have the tax dollars to support new infrastructure, or even maintain the infrastructure that we already have, as long as politician waste money on quick fixes which they hope will win them votes in the next election.

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flaja wrote:

engineer wrote:
Not necessarily. Once all the capital is available to fund useful projects, any extra just sits there unused or gets used on less desirable projects (see dot com bubble).

What extra can there be? The laws of supply and demand guarantee that a surplus of investment capital will lead to lower interest rates which will encourage people to borrow thereby eliminating the surplus. And something like the dotcom bubble can have long term benefits. Without that bubble I doubt that the internet would be what it is today because the dotcoms fueled computer sales as well as website/internet R&D.

But in this case, demand is restricted by another variable. Businesses will not borrow even at very low interest rates if they don't have something to spend the money on. I know that in my business, each business opportunity or project is extensively evaluated and unless it has a certain payback, it is shelved. Interest rates impact that payback slightly, but not significantly. Often the cost of capital line is a footnote. The business is not going to borrow to fund projects that don't make the cut just because cash is readily available. The same view is taken by venture capital firms. If an idea has merit, it has merit at 5% or 6% capital rates. If it doesn't have merit, it doesn't have merit. There are some folks who might see low interest rates as an opportunity to start their own businesses, but they aren't going to use up all that money.

However, overall, we seem to be somewhat in agreement at least on the first point: Given an extra dollar right now, I think the government should build infrastructure. We may disagree on my next belief: Given an extra dollar after the sufficient infrastucture has been completed (as designed by a well thought out plan, not a pork system), the deficit should be reduced. Finally, once the deficit is paid down (or at least under control), taxes should be reduced.

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Ragman wrote:

... giving people decent health care that works.

There is excellent health care available in the USA. All you need to do is have ready cash/health insurance and the will to get up, leave your house and pay a visit to your Physician.

Why should we be a "GIVE-ME" Society?

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Eva wrote:

Absolutely, it's an election-year stunt.

Does this mean folks will be sending their checks back?

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engineer wrote:

But in this case, demand is restricted by another variable. Businesses will not borrow even at very low interest rates if they don't have something to spend the money on.

If the interest rates are low enough, businesses and risk-takers will find something to spend borrowed money on.

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I know that in my business, each business opportunity or project is extensively evaluated and unless it has a certain payback, it is shelved.

What business are you in? And just how can any business have a guaranteed payback? A company could make absolutely no changes in how it operates and still go bankrupt without taking any risks if the economy in general turns bad.

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The business is not going to borrow to fund projects that don't make the cut just because cash is readily available.

But there will always be somebody who is willing to risk a financial loss by investing money in hopes of getting much greater financial gains.

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The same view is taken by venture capital firms. If an idea has merit, it has merit at 5% or 6% capital rates. If it doesn't have merit, it doesn't have merit. There are some folks who might see low interest rates as an opportunity to start their own businesses, but they aren't going to use up all that money.

Then explain how a consumer product like Pringle's potato crisps ever became a profitable product. I've heard that this product was a complete flop when it first appeared on the market. But the manufacturer stuck with it and used PR to create a market for it. The product could still have failed and the PR would have been throwing good money after bad, but the producer took the financial risk anyway. Nothing ventured, nothing gained.

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flaja wrote:

engineer wrote:
But in this case, demand is restricted by another variable. Businesses will not borrow even at very low interest rates if they don't have something to spend the money on.

If the interest rates are low enough, businesses and risk-takers will find something to spend borrowed money on.

But those things will be poor risks. Throwing money after poor risks in not good business.

flaja wrote:

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I know that in my business, each business opportunity or project is extensively evaluated and unless it has a certain payback, it is shelved.

What business are you in? And just how can any business have a guaranteed payback? A company could make absolutely no changes in how it operates and still go bankrupt without taking any risks if the economy in general turns bad.

There are no guarantees, but projects are evaluated on expected returns and the projected probability of getting that return. High risk requires a high potential return. High risk with low return probability rank low on the list.

flaja wrote:

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The business is not going to borrow to fund projects that don't make the cut just because cash is readily available.

But there will always be somebody who is willing to risk a financial loss by investing money in hopes of getting much greater financial gains.

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The same view is taken by venture capital firms. If an idea has merit, it has merit at 5% or 6% capital rates. If it doesn't have merit, it doesn't have merit. There are some folks who might see low interest rates as an opportunity to start their own businesses, but they aren't going to use up all that money.

Then explain how a consumer product like Pringle's potato crisps ever became a profitable product. I've heard that this product was a complete flop when it first appeared on the market. But the manufacturer stuck with it and used PR to create a market for it. The product could still have failed and the PR would have been throwing good money after bad, but the producer took the financial risk anyway. Nothing ventured, nothing gained.

A perfect case of where the management evaluated the potential benefit and decided that there was value in continuing. Trust that the conversation happened. The risk versus the reward was discussed and all the assumptions checked. Investment firms don't work like the lottery, throwing money at everything to see what sticks. Just because there is money available, companies don't just spend it. Exxon is sitting on $30+ billion in cash. They will spend it one day on good projects, but right now they are sitting tight because the right opportunities aren't there.

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engineer wrote:

But those things will be poor risks.

What things? I didn't specify anything in particular. All I said is that if money is cheap enough to get, there will be somebody who is willing to risk spending it.

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Throwing money after poor risks in not good business.

Then how do you explain the R&D that goes into completely new products? How did the CD-rom replace the floppy disk if no one was ever willing to take the financial risk involved in designing the CD-Rom? How would cell phones be the norm rather than the exception now if nobody risked a loss of R&D money?

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There are no guarantees, but projects are evaluated on expected returns and the projected probability of getting that return. High risk requires a high potential return. High risk with low return probability rank low on the list.

Care to give some specific examples? What was the expected return on the investment needed to design and market Pringle's or any other completely off-the-wall consumer product? And how do you explain wildcatting in the oil industry? Why do people risk digging a hole in the ground just on the off chance that it might have oil in it?

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A perfect case of where the management evaluated the potential benefit and decided that there was value in continuing.

The manufacturer spent money to design Pringle's. They then put Pringle's on the market and the product was a complete flop. At that point the R&D money that had been invested was likely a 100% loss. So why risk even more money in PR? What expectation was there that Pringle's would ever be a profitable consumer product? Like it or not there are some products that no amount of PR can salvage- Beta VCRs, the Edsel, the Commodore computer, the Mom and Pop video rental store that opened on the corner a year before the first Blockbuster came to town. In such situations the initial R&D or startup money that was invested becomes a total loss. But these total losses never stop some people from investing again.

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Investment firms don't work like the lottery, throwing money at everything to see what sticks.

Not all R&D efforts come from investment firms. If we were to eliminate the income tax for the auto companies, I would venture that at least one of them would use the extra money to R&D new auto designs or build new and more efficient factories for the designs that they already produce.

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Just because there is money available, companies don't just spend it.
Exxon is sitting on $30+ billion in cash. They will spend it one day on good projects, but right now they are sitting tight because the right opportunities aren't there.

Just how long do you expect these companies to be satisfied with the bank interest that their cash pots can earn? This money will either be invested or the stockholders in these companies will demand higher dividends before too terribly long.

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Tax Refunds as Stimulus?

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