Investment tax credit as fiscal stimulus

by on January 21, 2008 at 7:40 am in Economics | Permalink

It looks like we will get some fiscal stimulus, despite my cogent objections (I know, big surprise.)  One part of the stimulus package will probably be an investment tax credit which does have some good properties.  Unlike traditional fiscal policy an investment tax credit cannot be fully crowded out and it works best when it is expected to be temporary. 

Cuts in income taxes and increases in spending must be paid for somehow, so traditional fiscal policy can be crowded out by declines in private spending (My colleague Russ Roberts says fiscal policy is like trying to raise the water level by dipping a bucket in the deep end of a pool and dumping it in the shallow end.)  But an investment tax credit works through a change in incentives – it increases the incentive to invest now, when times are tough, at the expense of less future investment when times are better.

Also, cuts in income taxes stimulate the least when they are expected to be temporary.  But in contrast, an investment tax credit stimulates the most when it is expected to be temporary.  (A temporary credit must be used now or lost while a permanent credit gives you the option to wait).

Thus, a broad-based, temporary investment tax credit has some appeal as fiscal stimulus.   

sa January 21, 2008 at 8:57 am

One of the best posts on MR ever. I wonder our economics
profs could be so clear and concise instead of writing
unwieldy tomes.

Ken January 21, 2008 at 10:13 am

A standard Keynesian response to your argument would be that firms will
not make investments in new plant and equipment unless there is
sufficient aggregate demand. Otherwise, consumers will not purchase
the additional output generated by such investments. An investment
tax credit might improve things at the margin, but a typical Keynesian
would say the focus should be on increasing aggregate demand. How
would you counter that argument? Furthermore, you point to the
crowding out argument, which I do believe exists. However, I was
always told the evidence indicates there is some partial crowding out,
but not enough to make fiscal policy totally ineffective. How would
you counter that argument?

Ken January 21, 2008 at 10:39 am

One other argument one could make: A Ricardian Equivalence argument
would say that things like temporary tax cutes and rebates are
ineffective in increasing aggregate demand because households would
save the increase rather than spend it because they know they’ll
have to pay it back sometime in the future. However, I thought the
empirical evidence demonstrated there wasn’t much evidence for
Ricardian Equivalence. However, all the Keynesians that I encountered
always favored increases in goverment spending over lowering taxes.

R. Richard Schweitzer January 21, 2008 at 12:32 pm

Here we go! back to Macro – the whole body treatment (“aggregate demand” objectives, etc.)- ignoring organ malfunctions and failures. What, within reasonable diagnosis, is malfunctioning or failing, and why? Is it just “dehydration;” or is it not something more consistent that we should pinpoint, even if it can not be “treated” directly via interventionist principles?

“Incentives” are pallatives via those interventionist principles. They are justified because they are not likely to do “much” harm.

Why not examine for “disincentives,” residuals left over from other Macro approaches, and affecting organ functions in the body economic.

Let us be grandiose and immediately reduce the current FICA tax to the level that exactly matches the needed outflow from the system, rather than direct the excess to leak into the spending mechanisms. Cut the payroll taxes by reducing withholding levels. Eliminate the uncertainties on future taxation increases.

Establish a “permanent” federal borrowing program, pursuant to which all spending is done from borrowing only; appropriate and spend federal credit, not its revenues. Assign all taxation revenues only to payment and servicing of debt, on specified schedules. When a spending authorization is enacted, it must be accompanied by a directive to the Treasury to issue debt to cover that spending – no choices.

The “disincentives” are here, there and everywhere, the effects of many have been noted on malfunctions of the organs. “Holistic” approaches may be fine for maintaining health, and need to be observed even in disorders, but understanding and dealing individually with the organs of the body economic deserves priority.

R. Richard Schweitzer
s24rrs@aol.com

odograph January 21, 2008 at 1:26 pm

I am no longer sure that stimulus is not the lesser evil. It would be nice if we had a clean slate before needing a stimulus, but what can we do?

spencer January 21, 2008 at 2:12 pm

John Thacher — when I look at the spending data in 2001 it looks to me that the tax rebates stimulated a very large rebound in spending.

http://angrybear.blogspot.com/

shawn January 21, 2008 at 2:25 pm

let’s try that again did that work?

andy January 21, 2008 at 3:07 pm

It seems to me that what the government is trying to do with these stimuli is only to fool the people.

It’s the same as in african countries. The government promises to respect private property. Foreign investors build a factory. The government comes and nationalizes the factory. Great fiscal stimulus, isn’t it?

Of course the investors aren’t such fools and soon start to hedge against the government. That’s why the government must find new ways to defraud the people.

How does the fiscal stimulus work? Currently it is just printing money (the FED fixes the interest rate, thus prints the deficit). Just wonder how could printing money be considered as a way out of recession…

Anonymous January 21, 2008 at 5:05 pm

Stimulating because a credit is temporary makes sense because it creates a sense of urgency – the dire need for Americans to spend now, which increases demand for goods and services. However, in the long run, isn’t that exactly what it is – temporary? Over the past few years isn’t that what we’ve accomplished? Take out variable loans on mortgages because they are at an all time low; and when the rates go up, foreclosures are eminent. Of course the demand for the loans was at an all time high when the rates were low, but it wasn’t sustainable (or permanent). Now banks have to be more careful on who qualifies for a loan, and the demand for another service seems to be inevitable – increasing individual bankruptcy.
We don’t need policies in place that act like a band-aide and make things look good for a few months, or even a few years. We need a way to increase demand because American’s are financially capable!

Jacqueline January 21, 2008 at 5:55 pm

TypePad really needs to fix that leaving tags open at the end of comments thing.

For future reference for would-be tag closers, “i” and “em” in brackets both open italics, and thus you need to try both /i and /em (or a bunch of /i and /em in case there are multiple open italics) to close them.

SoftwareEng January 31, 2008 at 12:04 pm

Economic Downturn Structural Not Cyclical

Our current economic downturn is the direct result of an imbalance in the global economy precipitated through labor arbitrage. Prior to our current condition labor markets were relatively confined within nation state boundaries. Within these boundaries nation states enacted laws in varying degrees to ensure (at least in most developed countries) that labor was provided basic protections against an often times capricious employer. In addition, to laws governing basic worker rights, labor was afforded the right to organize into unions, guaranteed a wage above the level of subsistence, and afforded job security enforced through business custom.

Most important was the assurance that today’s job would not become the lost job of tomorrow. But once the global economy surged past the nation state breakers the obliteration of labor security commenced unabated. With the outflow of corporate capital in search of cheap labor abroad and unregulated inflow of foreign labor via “Temporary Worker Visa† programs (L-1, H1-B, and others) no job was any longer secure regardless of profession. There was talk of retraining workers displaced by these free (or was it lopsided) trade effects but as more and more workers became displaced across a multitude of professions the talk subsided and the realization set in that all meaningful employment had vanished from the United States. The result was a liquidation of competence, purchasing power (consumption), and a once throbbing heart of global economic dominance.

At this point businesses around the globe finally realized that a vibrant global middle class capable of purchasing had died a slow and agonizing death. Slow in that little by little year by year their numbers declined has jobs were lost to lower cost labor markets. But this new army of low cost labor wasn’t able to sustain the insatiable consumption of the global economic engine – its meager wages could barely sustain the basic necessities of existence. The race to the bottom was complete – the economic engine back fired one loud and last gasp for consumption – then expired.

The above will be our shared future both capital and labor if we don’t fully realize that one without the other does not make for an economy. Greed can only be a short term benefit for the long term result is an extreme maldistribution between capital and labor that eliminates any possibility that labor will easily regain a lost middle class propensity to consume. Granted capital will enjoy their excess wealth but this is a hollow transitory victory.

We must come to the realization that our current economic condition is a structural defect that can be remedied only if we work together.

To read further go to:
http://structuraleconissues.blogspot.com/

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LisaMonroe September 15, 2010 at 1:05 pm

What about the expatriate income tax? How many people actually know what that is and how you must deal with it?

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