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An interesting experiment in behavioral economics

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February 13, 2009 – Comments (7)

Conventional wisdom amongst many economists, including an non-professional followers of the dismal science such as myself, is that one-time tax payments are much more likely to be saved than spent.  This is certainly what happened last year when the government mailed out lump sum stimulus checks to Americans.

The government is taking a slightly different approach this time, altering its withholdings from workers' paychecks.  The theory behind approaching the tax break in this manner is that lump sum payments are more likely to be chucked into a savings account, but when the money trickles to consumers a little bit at a time they are more likely to spend it.

While it certainly is not being conducted in a vacuum and the economy may be so messed up that nothing would help it at this point, it will be interesting to see if the approach that the government is taking this time around will be more effective than it was last time.

I am of the personal opinion that non-permanent tax cuts that come at a time when consumer confidence is sitting at a record low will likely be saved no matter what whenever possible. It will be interesting to see what happens to this money.

Deej

7 Comments – Post Your Own

#1) On February 13, 2009 at 8:27 AM, Gemini846 (58.46) wrote:

The fact is that people living outside thier means or who didn't have a strict spending plan blew the check within a couple of months no matter how strong their desire to save it.

Other people who didn't need the money saved it, invested it or what have you. These people will do the same with the $20 in thier check it will sit in thier checking accounts.

Thus is the nature of all money isnt it?

What about people who are self employed? Do they pay less quarterly too?

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#2) On February 13, 2009 at 8:40 AM, TDRH (99.66) wrote:

The stimulus last summer went into the gas tank.   Timing is everything and their timing was poor.

I read an interesting article that said a "card" credit, like a gift certificate would be the best way to trigger spending and it made sense when I thought about it.  You get a check, you have to take it to the bank.  You have card in your pocket with $300 on it, you are going to spend it.

The small amount per week is better than nothing, but I do not think it will make much difference in the employment picture.   As much as Voodoo economics/trickle down etc was made fun of, it makes more sense to me than giving every American $600 to spend on Chinese imports, beer cigarette and gasoline. This will do little to create jobs.

 

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#3) On February 13, 2009 at 9:25 AM, Varchild2008 (85.20) wrote:

Self Employed workers get screwed every paycheck from extra high entitlement payments to the FEDs.  They have to fork over their own health care costs....granted there are ways to knock those costs down, but never nearly as much as a large employer can provide.

Also, living by contract to contract sorta destroys one's confidence that they can spend any money they get from any stimulus package.  The extra money will most definitely get saved or invested or spent towards their Health Care costs.

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#4) On February 13, 2009 at 9:36 AM, FreethinkerKW (63.83) wrote:

I'm with Deej on this one. Stats from the Fed Reserve show our savings rates jumping. We become less a nation of mindless consumers and more a nation of thinking Citizens.

 

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#5) On February 13, 2009 at 9:43 AM, saunafool (98.81) wrote:

I'm going out on a limb here. Tax cuts won't stimulate the economy at all from where we are.

When Kennedy cut taxes, top marginal rates were 90%. When Reagan cut taxes, top marginal rates were 75%. I can see where cutting the top rates from punitive levels might encourage business formation and other beneficial economic activity. After that, unless you are talking about cutting everyone's rate by 50%, I don't think it does much good. I think the data is flawed by falsely attributing the growth in the 80's to tax cuts.

I'd argue that Volcker hiking rates to kill inflation was the biggest reason behind the economic growth of the 80's. Reagan inhereted falling interest rates for his entire term.

The fed fund rate fell from 19% in January 1981 when Reagan took office to 9% in January 1989 when he left office. Cutting interest rates by 10% surely added more juice to the economy than the tax cuts.

Yet, all we hear about is how Reagan inherited an economy that was bogged down by lousy economic policy by Carter (who endured interest rates rising from 4.6% in 1977 to 19% in 1981) and how tax cuts and tax cuts alone were responsible for the "economic miracle" which followed.

I'll tell you what. Put interest rates at 19% when I start my presidency and let me cut rates for 8 years and I'll have a great economy. I don't care what the tax rates are.

Most importantly, in the current situation, it doesn't matter what you do with tax rates (to the degree of $1000 here or there) because people are going to save the money. Spending is contracting. After decades of living on credit, Americans are returning to a net positive savings rate. There is no reversing this trend, and in fact, this is a good thing because only when people have real money will the economy be able to grow again.

Therefore, the Keynesian moment. The best stimulus right now will be the government spending on infrastructure, education, health care, energy, and research. Everything else is pushing on a string.

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#6) On February 13, 2009 at 10:28 AM, GNUBEE (28.48) wrote:

Deej,

I agree there will be more saving, but to segregate and save that $20 each week takes work. And we all know the masses will probably not adhere to a savings regimen like that.

I think the Govt. was right in their execution, and that the money will be more likely spent, then saved.

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#7) On February 13, 2009 at 6:39 PM, TMFEldrehad (99.99) wrote:

Conventional wisdom amongst many economists, including an non-professional followers of the dismal science such as myself, is that one-time tax payments are much more likely to be saved than spent.  This is certainly what happened last year when the government mailed out lump sum stimulus checks to Americans.

I've never really understood this line of reasoning.  While on its face it makes some intuitive sense, what generally happens if a person puts his or her lump-sum payment in the bank and saves it?

Under normal circumstances the bank then loans that money out to someone else (or more than that amount in our fractional reserve system) - who then turns around and spends it.

Granted, today lending has slowed significantly, so today you may have a point.  Generally, though, under more 'normal' cirucumstances, unless the saver stuffs the money under his or her mattress, the money is still going to be spent by someone in the economy.

Of course I could be completely wrong. :-)

-Russell (a.k.a. TMFEldrehad)

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