Tax Rebates are Good, But Permanant Tax Cuts are Better

Anytime the government gives money back to the people, it’s a good thing, so I have no qualms about President Bush’s tax rebate of $800 per taxpayer, or $1,600 per couple. He ought to recommend it every year, not just when a recession threatens.

Bush did the same thing in 2001 only on a smaller scale: $300 per person, or $600 per couple. It did a lot of good to encourage a recovery in the economy, precisely because most people paid off consumer debt or saved/invested in the tax rebate. Those pundits on CNBC (and even President Bush) who said that if consumers don’t spend the money, the rebates would do no good, were proven wrong. The US economy started recovering right after the rebates went into effect. As I wrote recently in the Wall Street Journal, and the Christian Science Monitor, the economy is driven by supply-side saving and investment, not consumer spending. Consumer spending is the effect, not the cause, of prosperity.

Of course, I (and Wall Street) would prefer that President Bush take advantage of this dire economic situation to push for permanent extention of the 2001 Bush tax package instead of a stopgap measure. But this isn’t the first time this administration has disappointed free-market conservatives.

On the spending side, expanding the food stamp program and unemployment insurance can only make the recession or slowdown last longer! Studies show that unemployment insurance prolongs the unemployment lines. The unemployed don’t start seriously looking for new work until the benefits end.

What about the Fed?

Fiscal policy (taxes and spending) cannot alone end the recession. It will need the help of a sound monetary policy (interest rates and money supply). In fact, the Federal Reserve is the primary culprit in causing this slowdown/recession. It was the Fed under Alan Greenspan that lowered interest rates to 1% in 2004, far below the natural rate, and caused an artificial boom in real estate that was unsustainable, and when the Fed raised interest rates (which was inevitable), the boom turned into a severe credit crunch in the financial markets.

Moreover, the artificial boom was a global phenomenon. Most emerging markets, including the BRIC countries (Brazil, Russia, India, China) engaged in a similar easy-money policy in the past five years, and now we are paying the price. The global boom is now slowing.

The best policy the Fed and other central banks could do is provide a stable monetary policy, rather than engaging in easy money and tight money policies. Unfortunately, the Fed has a bad habit of overshooting — engaging in easy money followed by tight money. Hopefully, under Ben Bernanke, the Fed won’t make that miskake again, but I’m not counting on him. For the past six months, the growth rate of money supply (M2) has been falling sharply, which has precipitated the current economic crisis. I wouldn’t be surprised to see the Fed panicked again, and in concert with President Bush and Congress, aggressively cuts the Fed Funds Target Rate, and starts expanding the money supply again.