Sunday, August 23, 2009

Economic Fundamentals: Government Stimulus Programs That Are Actually Working And Why

Arguably, the two most successful government programs to stimulate economic activity have been the notorious "Cash For Clunkers" program and the first time homebuyer tax credit.

The Cash For Clunkers program gave consumers a $4,500 credit towards a new car if they traded in an older vehicle with worse gas mileage. While it's idiocy along the lines of Roosevelt era farm policy that used tax money to pay farmers not to produce during a time of hungry people and high unemployment, it did prompt a reaction. According to a New York Times article, the program generated 457,000 sales in less than a month, prompting automakers to boost production and recall laid off workers.

The $8,000 tax credit for first time homebuyers is also working. Writing for the AP, Alan Zibel noted, "first-time buyers are snapping up one out of every three homes."

In other words, a large part of the housing rebound is directly related to the tax credit. When it ends, economists worry that the housing rebound will end with it.

In Zibel's article, he quoted economist Robert Dye, who said, "I would not be at all surprised to see a dip at the end of the year once the tax credit expires."

Cash For Clunkers used tax credits to encourage people to invest in new automobiles, and it works. The first time homebuyers program uses tax credits to encourage people to invest in new homes for the first time, and it works too!

Do you see the similarity? Both programs use tax credits to encourage investment. Both programs work.

And what does spending money do? "We have tried spending money," Treasury Secretary Henry Morgenthau wrote to his diary in 1939. "We are spending more than we have ever spent before and it does not work. . . . After eight years of this Administration we have just as much unemployment as when we started. . . . And an enormous debt to boot!" (Source)

If the government was serious about generating positive economic activity, all spending would be stripped from the stimulus bill, except for infrastructure and other capital investment spending. Instead of spending money and piling up debt, we would reduce marginal tax rates across the board, but especially corporate tax rates and capital gains to encourage investment. It works.

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