Which Stimulus Package?

As I mentioned yesterday, stimulating the real economy must be one of Washington’s top priorities once the credit crunch begins to ease. The debate over how to do that is well underway. The Democratic Congressional leadership is preparing a stimulus package including increasing money for states and cities to replace their plummeting tax revenues, increased or extended unemployment benefits, increased food stamp aid, and public works (infrastructure) projects. All of these steps would have the effect of increasing spending by consumers and governments with the goal of dampening the recession, although public works projects could take months if not years to have an impact. One goal of the plan is to get money to people who are likely to spend it – hence the emphasis on lower-income people and cash-strapped local governments – to get it into the economy as quickly as possible.

Both presidential candidates are also talking about stimulating the economy, although their proposals are wrapped up in their broader campaign themes almost to the point of incoherence.

Barack Obama’s plan, released on Monday, includes immediate tax rebates, an extension of unemployment benefits, penalty-free withdrawals from 401(k) plans, increased funding to offset winter heating costs, $25 billion for state and local governments, emergency lending for small businesses, tax credits and tax cuts for small businesses, and $25 billion for infrastructure spending. (I’m both proposals dealing specifically with the financial sector and proposals that will obviously only have long-term effects.) Like the Congressional plan, the primary emphasis is on getting more money into the hands of people who will spend it quickly, although again the infrastructure funding could take a while to flow into the economy.

On Tuesday, John McCain announced a new set of proposals, including tax reductions on IRA withdrawals for seniors, reduced capital gains taxes, increased deductions of capital losses, and a suspension of the tax on unemployment benefits. Apart from the last, these tax reductions will benefit people in proportion to the amount they withdraw from their IRAs, the amount of their capital gains, and the amount of their capital losses – all of which mean people with more money will get more benefit. While there are arguments for this type of policy, it would probably slow the rate at which tax reductions turn into spending on goods and services. Of course, the centerpiece of McCain’s economic plans these days is his proposal for the government to buy whole mortgages from lenders and investors. Here, there has been a lot of confusion over whether the government would pay face value or market value for those mortgages (sound familiar? it’s the same debate we had over the Paulson asset purchase plan), and hence whether the plan would essentially be funded by taxpayers or by forcing investors to take losses. In either case, the net stimulus would probably be relatively small, since homeowners who previously could not afford their mortgages would now barely be able to afford their mortgages and hence would have little additional income for consumption. (Granted, the goal of the plan is to decrease foreclosures and to prop up mortgage-based securities.)

There is also a debate over the stimulus (which we will probably join soon) among a panel of economists over at the National Journal, where even the representative of the American Enterprise Institue says the case for a fiscal stimulus is “overwhelming.”

So start thinking about what you think should be in the eventual package.