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Economic Stimulus: What fiscal stimulus options are most effective?

The most effective fiscal policy options to stimulate the economy are those that would increase spending quickly and be short-lived. Those criteria can be met by policies that temporarily boost the purchasing power of households who are most likely to increase their spending quickly in response. Extending unemployment insurance beyond its normal twenty-six-week limit, raising food stamp benefits, or issuing refundable tax credits, all on a temporary basis, would likely provide the greatest fiscal stimulus in the shortest time.

  • Extend unemployment insurance benefits temporarily. Unemployment insurance protects workers against hardship due to job loss but weakens the incentive to find a new job. For that reason unemployment insurance benefits are generally limited to twenty-six weeks. But policymakers also recognize the need to extend benefits during economic slowdowns, when new jobs are harder to find. Such action could be even more important now, because the long-term unemployment rate (the share of the labor force out of work for more than six months) was nearly twice as high in the last quarter of 2007 as it was immediately before the 2001 recession. Because the funds would go to people whose income has fallen, nearly all would be spent rather than saved. Thus a policy of extending unemployment benefits offers a very high bang for the buck in terms of macroeconomic stimulus.
  • Increase food stamps temporarily. Another option would temporarily increase food stamp benefits, for example by 20 percent for each recipient for six months. This change could be implemented quickly just by raising the value of the electronic benefit cards issued to food stamp beneficiaries. This change, too, would be well targeted to families most hurt by an economic slowdown, who would spend essentially all of the extra income.
  • Issue refundable tax credits temporarily. Extended unemployment benefits and higher food stamp allotments would affect only a fraction of the population. Thus even the two combined would not provide adequate stimulus to offset a generalized downturn. Refundable tax credits, however, could move funds to virtually all households filing tax returns, and do so within a few months of enactment. For example, tax rebates enacted in February and based on 2007 tax returns could reach households over a five- to six-week period beginning in May or June. A refundable credit (one that can exceed taxes owed) would reach even the lowest-income households. This would maximize the share of the total outlay that would be spent rather than saved while providing assistance to those households most vulnerable to a weak economy. In contrast, a nonrefundable income tax rebate, like the one enacted in 2001, would exclude more than 25 million working households with no income tax liability; the result would not only be less fair but would also provide less stimulus bang for the buck. Making the credits temporary would ensure that they do not worsen the long-run budget outlook.
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