On the tax cut

One little-noticed bit about the tax cut. I don't think it will have much stimulus effect. Follow me through this thinking experiment.

The rate cuts are biggest in the top brackets; the top rate is cut from 38.6 to 35 percent, where people are more likely to save the money than spend it. (Econspeak: Their marginal propensity to consume is lower than that of the lower income people.) Likewise, the dividend tax cuts go to people who are more likely to save the money than to go out and spend it. (Higher income people are more likely to hold stocks outside of tax deferred accounts; the middle class typically holds its stocks in 401(k)'s and IRA accounts.) So, in general, what happens is that the investment in savings by these higher income people will be offset by the borrowing (dis-saving) by the government. Not a stimulus.

The child tax credit increase is more likely to provide some stimulus. Likewise, the rate cuts on middle-income people, and increasing the amount of income included in the lowest bracket. These cuts will stimulate consumption. However, there will be an offsetting drag on the economy from the deficit spending. Probably not right now, but as business investment starts up again, we'll have to look at cutting the deficits to make business investment grow.

How much these cuts will stimulate the economy, I'm not sure, but I think it will be something less than the 1 percent of GDP that is being mentioned in the press.

Another problem with the tax cut are the sunset provisions that keep the cost down to something less than $350 billion. These provisions make estimating the effect of the tax cut difficult. Recall the first tax cuts of the Bush administration? How they had phase-in and sunset dates? Then, as soon as it passes, the administration starts demanding that the cuts be put in now, and eliminate the sunset? If the cuts are not sent away after the sunset date, the 10 year cost would be somewhere between $725 and $800 billion, the bulk of which go to the divident tax cut and the highest tax bracket. If they do sunset, will a company pay a dividend one year, and then cut it the next year? That would make the company look like it's fortunes are declining. I think we will not see a lot of divident payments until that gets resolved.