A massive round of tax cuts that are likely to be the first salvo of the economic stimulus plan of President-elect Barack Obama could help pave the way for an eventual pickup in output, economists said on Friday. Facing possibly the worst economic crisis since the Great Depression, Democratic leaders in Congress on Thursday proposed an $825 billion package to help reverse a more than year-old recession.
The plan consists of at least $275 billion in tax cuts and $550 billion in spending, most of it for infrastructure, such as roads and bridges. Credit Suisse economists said on Friday the plan could bolster gross domestic product growth by 2 to 4 percentage points over the next two years beyond where it otherwise would be, and implementation could begin in the second quarter of 2009.
Deutsche Bank economists said earlier this week the Obama transition team estimate of 2 percentage points yearly impact of the stimulus in GDP growth may be somewhat optimistic. A timeline for the plan's implementation is not defined yet, and details could change as it wends its way through Congress and is subjected to lobbying. But tax cuts would be the swiftest course of action even if their immediate effectiveness remains open to question, the economists said.
Infrastructure projects take longer to ramp up due to the time-consuming process of bids and contract requirements and environmental assessments as well as political approval. "Tax cuts are a significant component (of the plan) as a means to generate stimulus on a reasonably rapid basis," the Credit Suisse economists said in a report. "The downside is that a significant fraction is likely to be saved."
A $150 billion stimulus to taxpayers paid out as tax rebates in 2008 failed to prevent a sharp decline in consumer spending. "We are well into the recession and still in a downfall. A stimulus in that environment generates a strong incentive to save the money, both for consumers and businesses," said Lakshman Achuthan, managing director at the Economic Cycle Research Institute in New York.
Achuthan said the part of the plan that should be implemented first was the near $160 billion destined for state and local governments, as well as $27 billion to extend the amount of time unemployed workers can claim benefits, which would help prevent further declines in spending. "We're talking about survival at this point, not about creature comforts," he said.
GDP in the fourth quarter, which the government is due to report on January 30, is estimated to show the economy shrank 5.1 percent in the last quarter of 2008. Deutsche Bank said that even if the proposed tax cuts are saved and not spent, they would help bolster the private finances of Americans, whose consumer spending accounts for two thirds of the US economy.
"Even if not spent, however, those tax cuts will still be facilitating a needed adjustment in household balance sheets," the bank said. That could help provide consumers with the confidence needed to spend again, once the boost from the infrastructure component of the stimulus plan kicks in, Credit Suisse said. "We think that is a clever feature in the stimulus design," the bank's report said.