Wednesday, January 21, 2009

Suspend State Sales Taxes!

The main point of a fiscal stimulus package is to offset the decline in consumer spending, which accounts for over 70% of GDP. We need to avoid the Paradox of Thrift, and all that. As Paul Krugman put it:

[W]hat the economy needs now is something to take the place of retrenching consumers. That means a major fiscal stimulus.
The argument against tax cuts as fiscal stimulus is that consumers won't spend the extra money, but rather will increase savings or pay down debt. We want people to spend, and spend now. So why oh why aren't people talking about temporarily suspending state sales taxes as a way to quickly increase consumer spending? Suspending state sales taxes would encourage consumers to spend more by lowering the price of spending, and making the suspension of sales taxes temporary would encourage consumers to spend before the sales tax holiday is over—that is, to spend right now. Laurence Kotlikoff and Ed Leamer have offered a very nice sketch of how such a policy would work. The proposal has been endorsed by Stanford's Robert Hall and Susan Woodward, and was evidently quite a hit at the annual American Economics Association meetings, winning converts like Alan Blinder of Princeton. Here's Kotlikoff and Leamer's overview of their proposal:
A better way to spur consumer spending is for Uncle Sam to run a six-month national sale by having a) state governments suspend their sales taxes and b) the federal government make up the lost state sales revenues. The national sale could be implemented immediately. Here’s how it would work. Uncle Sam would pay each state a fixed percentage — say 5 per cent — of the 2007 consumption of its residents. States would be required to reduce their retail sales tax rates by enough to generate a six-month revenue loss (calculated using 2007 data) equal to the amount they’ll receive from Uncle Sam. For states with low or zero sales tax rates, implementing this policy requires making their sales tax rates negative, ie subsidising purchases. Shoppers would see a negative tax on their sales receipts, lowering their outlays. State governments would reimburse businesses for paying the subsidy and, in turn, be reimbursed by the Feds. States would be free to broaden their sales tax bases to apply the National Sale to all retail sales, not just the sales currently covered in their sales tax systems. To make the policy progressive, states could also reduce sales tax rates by more for goods and services that are disproportionately consumed by the poor. ... [This plan] will apply economic medicine where it’s most needed – on consumer spending, giving everyone an incentive to spend now and begin again to trust our economy and its institutions.
So why has this proposal been largely absent from the public debate? I have no clue.

5 comments:

Don said...

I began wondering about this idea in November because I thought that the VAT decrease in Britain was a good idea. I blogged about this on my own blog, which no one reads, on Dec.11, when I found the Woodward and Hall idea.
Since then, I've posted on it a few times on other blogs, and the only comment that I've received is that people won't notice a sales tax decrease, but I disagree.
One tiny problem, which is that, so far, there's not a lot of evidence in Britain that the VAT decrease is having much effect. Of course, it's too soon to tell.
I was for Alan Blinder being Sec. of the Treasury. Perhaps if he were, this idea might go somewhere. I agree with you that it's a very worthwhile attempt.
Finally, if you get a chance, can you look at this story:

http://www.bloomberg.com/apps/news?pid=newsarchive&sid=a2TPkOwjGLZY

I don't know the law, so I'm not sure what they're saying would happen.

Cheers,

Don the libertarian Democrat

Economics of Contempt said...

Don,

Well I'm glad I'm not the only one who thinks this idea has merit! It's such a straight-forward, elegant approach to stimulating consumer spending that I had to bring it up again as well, since my first mention of it also fell on deaf ears.

A decrease in VAT or sales taxes strikes me as something that's extremely difficult to evaluate contemporaneously. If you take the (reasonable) view that the biggest effect of a temporary VAT decrease will come from inducing consumers to shift their spending forward -- for example, buying things in 2009 that they were planning on buying in 2010 -- then measuring the effectiveness of the policy requires that you know how much consumers were planning to spend in 2010. Contemporaneously, of course, that's virtually impossible to know. So I'm not discouraged by the results of Britain's VAT decrease just yet.

As for the CDS issue, it's way too early to say whether bank nationalizations would constitute a "credit event" (which would trigger payouts on CDS contracts). The BofA analyst seems to be applying a nonexistent bank nationalization plan to the terms of a hypothetical CDS contract, which, needless to say, probably isn't the soundest form of legal analysis. The "credit event" definitions have gone through so many changes over the years that a bank nationalization will inevitably trigger payouts on some CDS contracts.

But I'm fairly confident that lawmakers will structure any nationalization plan so as to specifically avoid triggering payouts on the majority of CDS contracts. At least in the US, government officials have learned to fear the CDS market.

Don said...

Thank you so much for the reply.

Don tld

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