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Economic Stimulus or Vote Buying…You Decide

Below is an article from the Wall Street Journal from Arthur Laffer discussing the impact of the stimulus plan. Arthur’s analysis leads us to believe that we just have election year vote buying that ultimately negatively impacts the economy. The article is a great example of classical economic analysis, something that is sorely missing from our government’s policies. Get prepared to put on your “Whip Inflation Now” buttons as we seem to be repeating the past yet again.

That ‘Stimulus’ Nonsense

February 13, 2008; Page A27

Bipartisanship, a notion that stands as anathema to our basic political premise of checks and balances, has resulted in a stimulus package that will do enormous damage to the U.S. economy.

The idea is simple enough — just have the government write everyone a rebate check, and these rebate recipients will spend most of the money and create enough demand to pull the economy out of its slowdown. With a little luck, the people who supply the rebate recipients with their newly demanded products will also spend part of their added income on yet more products, and so on and so forth until the full effect of the rebate is multiplied manifold and provides a much greater and much needed boost to the U.S. economy.

This logic is totally correct as far as it goes. Unfortunately it doesn’t go far enough.

The proposed rebate of about $600 per man, woman and child is transferred to people based upon some characteristic other than work effort. In fact, if you’ve worked too hard and earned too much, you won’t get a rebate. So in some instances the rebate actually requires the absence of work effort. Now it’s true that some of the people receiving the rebate may also be workers, but working is not the reason each person receives the rebate; it’s simply because he or she is a human being. Thus rebate recipients are given command over real resources for doing something other than working.

In this world of ours, those resources going to the rebate recipients don’t come from the Tooth Fairy. They have to come from workers and producers. If the resources come from workers and producers who thereby receive less for their work than they otherwise would have received, won’t they in turn spend less? Of course they’ll spend less, and the people who now supply them with less will also spend less, and so on down the line.

As my former colleague and friend Milton Friedman liked to say, “There’s no such thing as a free lunch,” and this rebate is exactly what he meant. The net effect is that the reduction in demand from those who pay the real resources will be exactly the same size as the increase in demand from the rebate recipients. It’s sad but true. Income effects always net to zero in a closed system.

To see this point from a more generic standpoint, if the price of apples rises, it is true that apple growers are better off. Their income effects go way up, and they can spend more. But apple consumers are worse off because their incomes go down by the exact same amount, and they have to spend less.

All of the stimulative effects of the rebate to the recipients will be 100% offset by the destimulative effects of the increase in liabilities of the workers and producers who have to pay for the transfer of resources to the rebate recipients. There is no stimulus from a rebate, period.

But even though the income effects net to zero, the substitution effects accumulate, and they accumulate in a most unpleasant way. This should be obvious to even a person untrained in economics. Ask yourself why not a $40,000 rebate per person, indexed for inflation of course, if a $600 rebate is so good. Heck, why don’t we give rebates equal to GDP, so that everyone who doesn’t work and doesn’t produce receives everything, and all those who do work and do produce receive nothing?

GDP would go to zero in a New York minute if workers and producers got nothing for their work effort. And, as fate will have it, any rebate will reduce output because it reduces incentives to produce output. The larger the rebate, the greater the reduction in the incentives to work and the greater the reduction in output. It’s as simple as that. This $170 billion rebate camouflaged as economic stimulus will deal a serious blow to the economic health of the country.

But there’s also collateral damage. Few in Congress understand or care. They think their actions either don’t matter or that they would see a positive impact from their actions if only they did more. If the economy worsens and when their political sensors become alarmed, they’ll up the dose, and goodness knows just how far this vicious cycle will take us. A quick glance back at the 16 years of presidencies of Lyndon Johnson, Richard Nixon, Gerald Ford and Jimmy Carter should give you pause. Whenever you observe bipartisan cooperation, hold on to your wallet and run to the basement.