Re: Federal Budget Deficit Expected to Reach Over $300 Billion

["Dr. Bruce R. McFarling" <Bruce.McFarling@xxxxxxxxxxxxxxxx>]

On Sun, 26 Jan 2003 14:52:50 -0500,
STEPHEN BLOCK <blocks@xxxxxxxxxxxxxxxxxxx> wrote:

>A question:

>It is assumed that deficits are stimulative. But is it the case
>that they are _inherently_ stimulative, or are they stimulative
>primarily when the deficit is the result of increased government
>spending, and not just because of a reduction in revenue? If they
>are inherently stimulative, can anyone explain how that works?

Government spending is directly stimulative, because what
they buy necessarily provides effective demand.

Tax reductions are indirectly stimulative, by increasing
disposable incomes.  The additional consumption decision
between the government policy decision and the stimulus
normally implies a weaker stimulus, by the propensity to
consume (share of new income that tends to be spent rather
than saved).  If that is a relatively modest increase per
person spread around a lot of people, as with, say, raising
the personal deduction (tax free threshold in Australia),
then it would take a very broad based sentiment in favour
of not spending that disposable income to fall very far
short of the expected impact.

Of particular concern is that a reduction in taxation
on income on dividend income, since more of that
decision whether to spend or save that income comes
under a relatively small number of people (institutional
investors, wealthy individual investors) making
decisions regarding bigger chunks of money at a time.
If there is a strong tendency to hold the tax cut as
"reinvested" dividends, it might not have a major
stimulus effect.

Of course, if the political cause of fighting the
dividend income tax cut was lost, it would be
preferable for the corporate tax paid on the
dividend income to come back as franking credits,
rather than dividends to be tax free, since tax
credits retain the principle of progressive income
tax.

The notion that investors in corporations should
essentially recieve the substantial social benefit of
limited liability for free, which is the essence of
the "no double taxation" argument, is an odious one,
and its a shame that most Americans get their news
from direct beneficiaries of this notion.