The American Recovery and Reinvestment Act — aka the stimulus bill — was the first bold stroke of the Obama administration. Most economists agree that the act prevented the economy from plunging into a deeper recession, even a depression.
But this wasn’t the last recession the U.S. will face, nor will it be the last stimulus plan that Congress will pass. There will be future recessions, and future debates over what government can do to prime the economic pump. Which raises the question: What should the stimulus next time look like?
The stimulus enacted by the administration was a cocktail of different measures aimed at jump-starting the economy: direct investments by government, federal aid to states, tax cuts. In the October 2010 issue of Business Economics, economists Laurence Seidman and Kenneth Lewis of the University of Delaware’s Lerner College of Business and Economics propose a new idea that policymakers should consider throwing in the mix next time around: a temporary federal discount.
The idea behind it is the same for any stimulus: get people to spend money again. Stimulus plans generally do this by either spending money on government programs that lead to jobs and relief — thus leading to more spending — or by putting more money directly in the hands of the public in the form of tax cuts (as Obama did) or rebates (as George W. Bush did in 2001).
The problem with the latter approach has always been that consumers oftentimes would rather stuff the extra money under the mattress — which obviously dulls a tax cut’s stimulative effect.
Here’s where Seidman and Lewis’ idea comes in. Instead of sending money to taxpayers in the hopes of sparking spending, the government would instead set a federal discount that would lower prices on goods and reimburse retailers the amount of that discount. For instance, if, as the authors recommend, the government sets a 20 percent discount, retailers would slash their prices 20 percent — with the expectation that the government would reimburse retailers every dollar of that discount for every item it sold.
In this scenario, a department store that ordinarily sold a refrigerator for $1,000 would slash its price 20 percent to $800. Consumers would pay the $800, and the government would make up the $200 difference to the department store. Not only would the lower price on the fridge incentivize the consumer to buy it now, the lower price leaves $200 of savings in his or her pocket to spend or keep as they please.
Seidman notes that other price incentive measures to stimulate the economy have been proposed in the past. During the 2001 recession, Princeton economist Alan Blinder suggested that the federal government reimburse state governments that temporarily cut or suspended their sales tax. Also around that time, Martin Feldstein of Harvard suggested that Japan temporarily cut its value-added tax during its recession.
But for those ideas to work, Seidman says that “you have to have a tax in place,” and the U.S. has neither a national sales nor value-added tax. The federal discount idea essentially sidesteps that problem while still offering a price incentive.
An important wrinkle to Seidman and Lewis’s idea is that it would be only temporary. In their conception, the discount would be pegged to the unemployment rate — as the rate goes down, the discount slowly gets phased out. Seidman says that an automatic phase-down would defuse a common criticism of stimulus programs from the right.
“Is this just an excuse to get a permanent new program? That’s always the objection,” Seidman says. “Tying it to the state of the economy should fix that problem.”
The temporary nature of the program should also go a long way toward addressing a frequent knock against stimulus plans: their effect on the deficit. “If you leave the big spending program in place, then you got the deficit problem continuing,” Seidman notes. But by making the program temporary, it won’t be a burden on the long-term budget — and it would also allay fears that a discount would only perpetuate an economy that is already too consumer-driven.
In their paper, Seidman and Lewis simulated the impact of a federal discount from the fourth quarter of 2009 through the fourth quarter of 2010. According to their models, a 20 percent discount on both durable and nondurable goods would result in a 1.4 percent drop in unemployment, from 9.1 percent to 7.7 percent, while costing $600 billion. (The Obama stimulus came out to $787 billion.)
Despite that cost, a 20 percent discount would result in a rise in debt only slightly greater than would occur without the program. Without a discount, debt in the final quarter of the period accounted for 60.2 percent of GDP. With the discount, it was 62.3 percent — a modest 2.1 percent increase, especially considering the program’s considerable impact on unemployment. The reason for the surprisingly small difference is simple, Seidman explains.
“When you look at the numbers that come out of macroeconomists’ models, while the debt increases, so does the GDP. And that’s what you’re doing this for,” he says.
Seidman acknowledges that a discount program has its disadvantages compared to tax cuts or rebates: “The trade-off is that it’s not as easy administratively.” And he admits that direct investments by government and cash transfers to the unemployed would still have a greater “multiplier effect” than a discount. (That means a dollar spent on those programs produces a greater ripple in the economy than other programs.)
But government spending and unemployment assistance also happen to be politically unpopular forms of stimulus spending, so tax cuts — which are less stimulative — get enacted during downturns. For policymakers considering tax cuts or rebates as stimulus, Seidman argues that “having a price incentive should be more powerful.”
And it would probably be just as popular. Seidman points to one Obama price-incentive program that met with a huge response, and that also partly inspired his idea: “cash for clunkers.”
That program paid auto buyers a $3,500 or $4,500 rebate to trade in old, fuel inefficient cars for new ones. It cost the government about $3 billion all told, most of it snapped up by consumers as soon as the money went out the door. While some have argued that it merely moved forward car purchases that would have been made anyway, others — including Blinder, who thought up the program — note that that was the point: to boost auto sales in a period when the economy needed a shot in the arm and not necessarily for the long term.
Unlike cash for clunkers, the federal discount idea arrived too late to be considered for the most recent stimulus. “This idea might be for a future recession,” Seidman says.
But noting the current mania for deficit-cutting that has dominated the agenda, Seidman expressed concern about Congress’s policy priorities. “The issue for debt is the long run. It’s just not correct to be worrying about the deficit right now,” he asserts. If spending cuts rather than economy-boosting investments continue to rule the day in Washington, Seidman and Lewis may well see their idea come up for consideration sooner than anticipated.