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The state of the economy is on everyone’s mind due to the COVID-19 and the more frequent practice of social distancing. People are staying at home due to the virus, which will have a negative impact on consumption. On Tuesday, Treasury Secretary Steve Mnuchin said that the administration is “looking at sending checks to Americans immediately.” The idea is similar in approach to proposals from Sens. Tom Cotton (R-Ark.) and Mitt Romney (R-Utah).
The approach of direct cash-based assistance isn’t a new idea. On the surface, it may sound like a good approach. Americans get a check from the federal government based on the hope they will spend the money to boost consumption. In this instance, the direct assistance the administration appears to hopes to help some Americans meet their financial obligations, such as mortgage payments and utilities.
If the administration hopes to see an increase in consumption, however, history says that it won’t work. Not only are many people staying home in light of COVID-19, but the data show that people tended to save the money they received from the federal government rather than spend it. Some may have paid off debt, although there isn’t good data on this particular theory. A better way to boost businesses would be to provide a payroll tax holiday for an indefinite period.
In June 2001, President Bush signed the Economic Growth and Tax Relief Reconciliation Act. This bill was the first of two major tax bills that President Bush signed into law during his first term. The law not only cut marginal individual income tax rates and capital gain tax rates, among other changes to the tax code, it also created a 10 percent income tax bracket on taxable incomes of $6,000 for an individual and $12,000 for a married couple filing jointly. The maximum amount an individual could receive was $300. The maximum for a married couple filing jointly was $600.
These tax rebates were sent to taxpayers in the form of a check. The hope was that the tax rebate would have a stimulative effect on consumption. But did the 2001 tax rebate have the desired result? Different studies on the effect of the tax rebate have different conclusions. Using an idea from John B. Taylor of the Hoover Institution, who looked at the effect of the 2008 tax rebate, we’ve compared disposable personal income (DPI), which is after-tax income, to personal consumption expenditures (PCE) between January 2000 and December 2002. If the tax rebates were effective, we would expect to see a significant rise in both DPI and PCE. The data shows this not to be the case.
As the chart below shows DPI did rise after the passage of the 2001 tax rebate, but personal consumption expenditures (PCE) declined briefly before jumping and then declining again and leveling off. Not shown in the chart is the PCE-to-DPI rate. In December 2000, the rate was 91.6 percent. In May 2001 and June 2001, the PCE-to-DPI rate was 91.5 percent. It declined to 90.4 percent in July 2001 and 89.3 percent and 89 percent in August and September 2001.
Interestingly, the personal savings-to-DPI rate increased between July and September 2001. Prior to these three months, between January 2000 and June 2001, the rate had not exceeded 5.4 percent, which was the rate in January 2000. The personal savings-to-DPI rate increased to 5.6 percent in July 2001 and peaked at 7 percent in September 2001. The PCE-to-DPI rate increased in October and November 2001 to 92.6 percent and 92 percent before falling back to 91.6 percent in December 2001.
Personal savings declined to 3.4 percent and 4.5 percent in October and September 2001. Throughout 2002, the personal savings-to-DPI rate never dropped below 5.4 percent. The PCE-to-DPI rate didn’t rise above 91.1 percent in 2002.
One could surmise from the 2000 through 2002 data that many who received tax rebates decided to save the money rather than spend it or saved it knowing that they were receiving a check that could be spent later. Others may have paid off personal debt with the rebate. In February 2002, the White House Council of Economic Advisers released a short paper that claimed the previous year’s tax rebates “provided valuable stimulus to economic activity in the short run,” but there’s little evidence that is the case.
The Bush administration used a similar method 7 years later with similar results. In February 2008, President Bush signed the Economic Stimulus Act, which provided another round of tax rebates. Unlike the tax rebates in the Economic Growth and Tax Relief Reconciliation Act, the Economic Stimulus Act provided tax rebates to taxpayers, even those with no tax liability, who earned a minimum income of $3,000. Rebates were reduced for individuals with incomes above $75,000 and married couples filing jointly with incomes above $150,000 by 5 percent of their 2007 reported adjusted gross income. There were other tax aspects to the Economic Stimulus Act for individuals with children and businesses.
In 2008, the rise in DPI was even more noticeable around mid-year, but PCE declined substantially. Of course, in this instance, the recession began in December 2007 and lasted until June 2009, which, more likely than not, explains the decline DPI and the even more substantial decline in PCE.
What all these numbers demonstrate is something that fiscal conservatives have long known. Centrally planning the economic activity of millions is an effort in futility. Every time we have attempted using stimulus policies to stimulate the economy, the real-world impact has been negligible. Moreover, a direct cash infusion of the type Secretary Mnuchin has proposed would require financing billions of dollars in payments by taking on an incomprehensible amount of excess debt and all of the negative externalities that come along with it.
In short, the stimulus package that the administration has expressed support for would not only fail in its objective but would hold far-reaching consequences for our nation’s fiscal security.