Friday, February 27, 2009

Would You Go To An 8.25% Off Sale?

Here's the crux of the problem with creating stimulative policy with tax cuts:

Would you go to an 8.25% Off Sale?

In this economic climate, the policy challenge is knowing how much incentive it will take to get qualified, capable buyers to take the risk of spending their cash now, to the benefit of the economy, rather than to horde their money cautiously.

The 8.25% figure is the sales tax rate in the north Houston area. So the idea we ponder here is what would happen if localities entirely suspended the sales tax. Sounds dramatic, bold, right?

But am I really going to run out and buy a new suit for $200 just because I don't have to pay 8.25% in taxes on it? The price tag of things never includes taxes anyway, and most shoppers never think about the sales tax when they compare prices or consider purchases (mostly I suppose because so few people know how to calculate percentages such as proper tip amounts in restaurants).

So this plan would fail and fail big to stimulate spending.

Now let's think about people who basically spend everything they earn in wages because they need it all for basic living expenses: basic clothing, kids' apparel and needs, car payment, gasoline, groceries, hair cuts, credit card payments, utilities, rent... the basics for our economy.

Now let's think about suspending the 7.65% Medicare and Social Security (FICA) withholding from that person's paycheck. (A similar measure would be to reduce or eliminate federal income tax withholding.) For monthly wages of $3,000, this measure would generate an additional $229.50 per month on an annual income of only $36,000.

Such a tax break or "holiday" would be effective immediately, and eliminating the withholding would take effect immediately in the economy, almost guaranteed to be spent entirely and immediately. Now that's stimulation.

At an annual income around $36,000, this measure would reach immediately around two-thirds of American workers.

Not all taxes are bad. Not all spending is bad. The question is what policy is effective in this moment? Don't let the politicians and pundits take your eye off the ball.