Sunday, June 29, 2008

Tax Rebates Pump Up the Gross National Debt

Late last week, the Department of Commerce reported that personal income before taxes had grown 1.9% in May 2008, compared to April 2008. After taxes, personal income grew 5.7%. By contrast, in the preceding month, April 2008, personal income grew 0.3% before taxes and 0.4% after taxes. May looks good, no?

No. Most of the May increase was attributable to tax rebate payments from the IRS. Without these stimulus payments, personal income after taxes would have grown only 0.4% in May. That is to say, 5.3% of the May increase in after tax income was due to the government's stimulus payments.

Let's consider where the money for the rebates came from. The federal government is running a budget deficit to the tune of hundreds of billions. It didn't have any excess cash lying around in its vaults. If the government was already running a deficit and then sent out some $50 billion in rebates in April and May 2008, the only way it could have gotten the money was to borrow more.

But is there any public accounting for the borrowings? They'll show up eventually in government statistics about the federal debt and budget deficit. However, the personal income "increase" they created isn't really a net increase in income or wealth. It is simply a transfer of wealth from the future to the present.

This is no different than an individual who takes out a loan to get money for current use. The loan proceeds aren't really income. They are simply a frontloading of wealth from the future to the present. The borrower's future well-being will be diminished by the burdens of debt service and repayment. The future well-being of the United States will be similarly diminished.

The stimulus payments will only modestly increase the trillions of dollars of debt now carried by the federal government, and the additional interest expense might also seem relatively minor. But as the demographic composition of America changes, with fewer workers and more retirees, the impact of additional federal debt on taxpayers will be magnified. And if there are more stimulus payments, as some politicians are calling for, the impact on the federal debt will grow.

We're getting a misleading picture of the stimulus payments. They don't really increase personal incomes except in an immediate and misleading sense. Taxpayers, including the taxpayers receiving the payments, and/or their children, will bear the burden of repaying the debt taken on to fund the payments.

Government stimulus programs generally don't work. They were attempted in the 1930s, the 1970s, and the early 2000s, and had little lasting impact. The only stimulus program that truly revived the economy was World War II, when the federal government's budget--funded with war bonds and other borrowings--amounted to 50% of the economy. But war isn't an option today for economic policy. And the current stimulus program will have trivial impact, at best.

The stimulus payments reflect a belief that more debt will solve our problems. But that's how we got into trouble in the first place. People came to believe that credit was the way to attain a nice lifestyle. The fussy, old-fashioned notion of earning and saving went the way of the Model T. Income was simply a metric used to measure how much credit you could get. Credit became wealth. Buying a house with no money down was the smart play because you wouldn't have to save a penny and could spend your money on other things. Look how well we're doing now.

It would be nice if the government would set an example and stop treating credit as wealth. Policies designed to bolster manufacturing--the true foundation of national wealth--should be favored. Today, bread and circuses are the policies of choice in Washington. However, we should bear in mind how much good they did for the Roman Empire.

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