tax policy center
Tax Topics
tax topics
 

QUICK FACTS: Fiscal Stimulus

  1. What does the stimulus act do?
  2. Why do we need an economic stimulus?
  3. What approaches could provide economic stimulus?
  4. What are the advantages and drawbacks of each approach?
  5. What criteria should we use to evaluate stimulus proposals?
  6. What are examples of stimulus proposals would best meet the criteria?
  7. What are examples of stimulus proposals would rank worst?
  8. What have we learned from past attempts to stimulate the economy?
  9. What specific stimulus plans have policymakers and economists proposed?
  10. What specific stimulus plans have presidential candidates proposed?

Read more TPC discussion about fiscal stimulus

The following discussion relies heavily on a recent paper by Tax Policy Center fellows Douglas W. Elmendorf and Jason Furman, If, When, How: A Primer on Fiscal Stimulus, available at: http://www.brookings.edu/papers/2008/0110_fiscal_stimulus_elmendorf_furman.aspx


1. What does the stimulus act do?

The stimulus act has three main parts: an individual tax rebate and two business provisions that increase limits on expensing investment costs and accelerate depreciation of some investments.1

Recovery Rebates for Individual Taxpayers

  • Basic Credit Tax filers who are neither dependents nor non-resident aliens receive a basic credit that is the larger of either:
    • $600 ($1,200 for joint filers) but not more than the tax unit’s income tax liability before subtracting child and earned income credits OR
    • $300 ($600 for joint filers) if tax filer has either
      • at least $3,000 of earnings, Social Security benefits, and veteran’s payments OR
      • net income tax liability of at least $1 and gross income greater than the sum of the applicable basic standard deduction amount and one personal exemption (two personal exemptions for a joint return). That value is $8,750 in 2007 ($17,500 for joint filers and $11,250 for heads of household) and $8,950 in 2008 ($17,900 for joint filers and $11,500 for heads of household).
  • Child Credit People who qualify for a basic credit may also receive $300 for each child eligible for the regular child credit (typically a related child under age 17 at the end of the year).
  • Income Limitation The sum of the basic and child credits is reduced by 5 percent of the tax filer’s adjusted gross income over $75,000 ($150,000 for joint filers).
  • Advance Rebates Individuals who file 2007 tax returns will receive recovery rebates based on the information in their 2007 returns. They, along with others who receive no advance rebate, will complete a worksheet for their 2008 tax return to recalculate the rebate based on 2008 information. If that recalculation yields a larger rebate than the original calculation, the difference will be credited as a 2008 tax payment. If the recalculation yields a smaller value, the taxpayer does not have to repay the difference.
  • See tables for calculations of advance rebates for single and married taxpayers)

Temporary Increase in Limitations on Expensing of Depreciable Business Assets

Businesses may expense (i.e., deduct the full cost of) qualifying investment undertaken in 2008 subject to limitations. The stimulus bill doubles for one year the maximum amount of investment that firms may expense.

  • Qualifying investment is generally defined as “depreciable tangible personal property that is purchased for use in the active conduct of a trade or business.”
  • Expensing is limited to $250,000, reduced by the amount by which qualifying investment exceeds $800,000. Thus, for example, a firm that invests $750,000 could expense $250,000. A firm that invests $900,000 could expense just $150,000 because the $250,000 limit is reduced by the $100,000 of investment over the $800,000 limit.
  • After 2008, the limit on expensing reverts to $125,000 (indexed from 1997) with the reduction beginning when investment exceeds $500,000 (also indexed from 1997).

Special Depreciation Allowance for Certain Property

In addition to the amount of investment made that firms can expense, this provision allows firms an additional first-year depreciation of 50 percent of the cost of qualifying investments contracted for and placed in service during 2008.

1This discussion draws heavily from the Joint Committee on Taxation’s detailed description of the stimulus act in Technical Explanation of the Revenue Provisions of H.R. 5140, The “Economic Stimulus Act Of 2008” as Passed by the House of Representatives and the Senate on February 7, 2008, JCX-16-08, February 8, 2008.


2. Why do we need an economic stimulus?

Problems in the housing industry and disruptions in credit markets are leading economists and other observers to predict a slowdown in the U.S. economy, if not an actual recession. Given the underlying economic strengths and increased international competitiveness resulting from the declining value of the dollar, most economists expect any slowing or downturn to be brief. Nonetheless, a well-timed stimulus of short duration could help the economy weather a rough spot and help those people most affected by a slowdown.

3. What approaches could provide economic stimulus?

Three kinds of stimulus can boost the economy:

  • Automatic Stabilizers: A downturn in the economy automatically generates fiscal responses that stimulate economic activity. Job losses initiate unemployment benefits and other transfers while lost wages lower income and payroll taxes, both of which keep consumption from falling as much as it otherwise would.
  • Monetary Policy: The Fed can use its monetary powers to lower interest rates, making it easier for firms and individuals to borrow and maintain investment and consumption. The Fed can act quickly and stabilize or even raise rates when stimulus is no longer needed. However, if the economic mood is very poor, businesses may choose not to invest, and people may not borrow to support consumption, so simply lowering interest rates may prove ineffective. Similarly, banks may be unwilling to lend in the face of big financial losses.
  • Fiscal Stimulus: Rather than rely on automatic stabilizers to support consumption and investment, the government can stimulate consumer spending by increasing outlays or cutting taxes. Extending unemployment benefits, reducing payroll taxes, giving income tax rebates, or subsidizing business investment are all fiscal tools that could increase economic activity.

4. What are the advantages and drawbacks of each approach?

  • Automatic Stabilizers
    • Automatic stabilizers have two significant advantages: their effects occur with no need for government action and they take effect only when the economy is flagging.
    • Automatic stabilizers have powerful but limited effects: a 2000 study estimated that the decline in income and payroll tax collections offsets about 8 percent of a decline in GDP.
  • Monetary Policy
    • Monetary policy has two major advantages over fiscal stimulus: the Fed can act quickly to implement a chosen policy and is in a better position to identify the need for stimulus.
    • The Fed can, however, choose to counteract fiscal policies with which it disagrees, and thus holds the potential to defeat a fiscal stimulus.
    • Since September 2007, the Fed has cut its target for the federal funds rate by 1 percentage point to ease the availability of credit.
  • Fiscal Stimulus
    • Fiscal actions typically take effect faster than monetary policy and thus may shorten significantly the duration of an economic downturn. A properly designed policy that puts money in the hands of people who will spend it quickly can significantly affect economic activity in the same or next quarter. In contrast, much of the effect of monetary policies may not occur for a year or more.
    • Stimulus may also be essential when monetary policy has little effect, either because interest rates are already very low or because economic conditions are bad enough that people don’t respond to cheaper money.
    • Because their implementation typically requires legislative action, it may take longer for fiscal stimulus to get into place. Any lag runs the risk of coming not only too late to help the economy recover but also of actually overheating an economy that is already growing again.

5. What criteria should we use to evaluate stimulus proposals?

Most economists and policymakers agree on three criteria for successful stimulus, sometimes referred to as the “Three T’s”:

  • Timely: Any stimulus should take effect near the time when the economy weakens. Stimulus that becomes effective much later may have little benefit and can be counterproductive.
  • Targeted: To have the greatest likelihood of success, a fiscal stimulus should go principally to those who will boost the economy most quickly and strongly. At the same time, it should also be targeted to people affected most adversely by the downturn. Money delivered into the hands of low-income workers who have lost jobs, for example, will go to those both most in need and most likely to spend it. By contrast, the wealthy not only have less need for the windfall but are also most likely to save or invest it rather than use the money to increase consumption.
  • Temporary: In addition to a prompt start, any stimulus should have a scheduled termination. That would not only reduce risks of overstimulating the economy but would also hold down long-term costs and thus pose less of a threat to future economic growth.

6. What are examples of stimulus proposals would best meet the criteria?

  • Temporary refundable tax credits: providing the same size refundable tax credits to all workers would provide a large, widely dispersed stimulus. Mailing checks to workers based on last year’s earnings would hasten the proposals impact but impose significant costs on the IRS. Making the credits refundable would extend credits to more than 20 million working households that have no income tax liability.
  • Temporary extension of unemployment benefits: extending eligibility for unemployment compensation beyond six months would both assist the long-term unemployed and inject spending into the economy.
  • Temporary increase in means-tested assistance programs: increasing benefit levels for food stamps, energy assistance, or cash welfare programs would give resources to needy households who would likely use them immediately. Making the increases temporary would mitigate the negative incentives often attributed to such transfer programs.

7. What are examples of stimulus proposals would rank worst?

  • Make the 2001-2006 tax cuts permanent: many of the tax cuts made in recent years expire after 2010, but making those cuts permanent would give little or no immediate boost to the economy and instead could worsen things in both the short- and long-run. Such action would have no effect on after-tax incomes before 2011 and thus have no immediate effect on the economy. Indeed, some economists argue that the threat of future tax increases could spur short-term economic activity to avoid the higher taxes. Len Burman suggested, half seriously, that the best way to use the Bush tax cuts to stimulate the economy would be to speed up their expiration, not extend them. Even when the tax cuts would become effective, their benefits would go disproportionately to wealthier households, which are least likely to spend additional funds. And the negative impact on budget deficits and the national debt could lead to higher interest rates and thus adversely affect economic growth over the long run.
  • Cut tax rates: cutting tax rates across the board would work more quickly than making recent tax cuts permanent because the lower rates would become effective sooner. The two policies would, however, share the many negative effects noted above.

8. What have we learned from past attempts to stimulate the economy?

  • Tax rebates can quickly increase spending, particularly if focused on low-income households. In the summer of 2001, 90 million households received $38 billion in income tax rebates of $300 ($600 for married couples); households that did not pay positive income taxes received no rebates. Subsequent research found that households spent about one-third of the rebates in the quarter they were received and another third in the next quarter. Low-income households spent significantly more of their rebates than did the average household.
  • Tax incentives for investment appear to have relatively small effects and those effects may come well after the need for economic stimulus has passed. From September 2001 through 2004, businesses could immediately deduct half of any investment expenditures under a temporary tax provision called “bonus depreciation.” In subsequent surveys, only one-tenth of businesses reported that the incentives had much effect on their investment decisions. Researchers found that while bonus depreciation appeared to increase investment, the largest effects came after three years, well beyond the end of the economic downturn.

9. What specific stimulus plans have policymakers and economists proposed?

  • Ben Bernanke (Chairman, Federal Reserve Board): “…fiscal action could be helpful in principle, as fiscal and monetary stimulus together may provide broader support for the economy than monetary policy actions alone. But the design and implementation of the fiscal program are critically important. A fiscal initiative at this juncture could prove quite counterproductive, if (for example) it provided economic stimulus at the wrong time or compromised fiscal discipline in the longer term.”

    “A $100 billion package that provides $60 billion to $70 billion in spending would have ‘significant’ effects on economic growth in the second half of this year.” (quoted by Bloomberg News, 1/18/08)

    Any “stimulus package should be (1) implemented quickly;” (2) designed to have spending effects within the next year; (3) efficient in maximizing the increase in aggregate spending relative to its cost; and (4) “explicitly temporary, both to avoid unwanted stimulus beyond the near-term horizon and, importantly, to preclude an increase in the federal government's structural budget deficit.”---January 17, 2008 testimony before the House Budget Committee
  • Peter Orszag (Director, Congressional Budget Office): Indications suggest several quarters of slow economic growth and risks of a recession have risen. The Fed’s monetary tools may prove inadequate to prevent a recession and automatic stabilizers may only mitigate any economic downturn. Any economic stimulus deemed necessary should take effect when most needed and “increase economic activity as much as possible for a given budgetary cost.” The most productive stimulus would use tax rebates or increased transfers to direct resources to those most likely to spend them quickly. Finally, actions to address turmoil in mortgage markets must balance helping distressed families, “being fair to other families, and not rewarding imprudent behavior that might create additional costs in the future.”

    The testimony evaluates and compares the relative effectiveness of various ways of reducing personal taxes, providing incentives for businesses, and increasing government spending. It concludes with an examination of various actions the government could take to mitigate problems with the market for home mortgages.---January 22, 2008 testimony before the Senate Committee on Finance
  • Martin Feldstein (economics professor, Harvard University): While the Fed continues an expansionary monetary policy, Congress should enact a tax cut that would take effect only if the economy worsens. The stimulus could take many forms, including a flat rebate per taxpayer or a percentage reduction in each taxpayer’s liability. Various events might trigger the tax cut, most suitably a three month cumulative decline in payroll employment. The tax cut “would automatically end when employment began to rise or when it reached its pre-downturn level.”---December 5, 2007 testimony before the House Budget Committee
  • Lawrence Summers (economics professor, Harvard University): Implement immediately $50 to $75 billion in “across the board equal tax cuts or refunds for all taxfilers.” Percentage tax cuts would give a disproportionately large share of the cuts to high-income households, which are less likely to spend them than low-income households. Both business tax cuts and cuts in individual tax rates that would lower future taxes would have less impact. As long as the cuts are temporary, they need not be specifically paid for; their cost would have little effect on future economic growth and requiring that they be paid for could delay their enactment.--- January 17, 2008 testimony before the Joint Economic Committee

10. What specific stimulus plans have presidential candidates proposed?

Democrats

  • Hillary Clinton: Up to $110 billion stimulus package including (1) $40 billion in refundable tax rebates targeted to working and middle-class families; (2) a $30 billion Emergency Housing Crisis Fund to assist states and cities mitigate the effects of mounting foreclosures; (3) a 90-day moratorium on foreclosures and a 5 year freeze on interest rates on subprime mortgages; (4) $25 billion in immediate energy assistance; (5) $5 billion in accelerated energy efficiency and alternative energy investments; and (6) $10 billion in extending and broadening unemployment insurance.
  • Barack Obama: Inject $75 billion now and reserve another $45 billion if needed. Specific plan would (1) provide an immediate $250 tax cut for workers and their families; (2) provide an immediate, temporary $250 bonus to seniors in their Social Security checks; (3) provide an additional $250 tax cut to workers and an additional $250 to seniors if the economy continues to worsen; (4) provide relief to homeowners hit by the housing crisis; (5) provide aid to states hardest-hit by the housing crisis to avoid a slash in services; and (6) extend and expand Unemployment Insurance.

Republicans

  • Mike Huckabee: Replace all federal taxes with “Fair Tax,” a national sales tax on all goods and services. In short run, make Bush tax cuts permanent.
  • John McCain: lower the corporate tax rate from 35 percent to 25 percent, allow expensing of equipment and technology investments and establish a permanent research and development tax credit. Paid for by cutting “wasteful government spending.” Opposes short-term stimulus because of cost.

FOR MORE INFORMATION


    Advanced Search