“The largest piece of tax relief in the new plan would involve cuts for people
who pay income taxes or who claim the earned-income credit, a refund designed to
lessen the impact of payroll taxes on low- and moderate-income workers.”
This plan is probably as close as we can get politically to my proposal (see this post) to lift the FICA tax. Because the plan changes the withholding tax, it increases incentives to work at the same time the plan is moving cash into a large number of pockets. And, since the plan is aimed at low- to-moderate income groups, the money will appear in the pockets of those who are most likely to be liquidity constrained at the moment.
How much will the plan boost output? I expect the proposal to boost consumption directly by about $85 billion, or almost 1 percent of consumption. This increase is exceptionally large, but so is the stimulus.
But, there is also a sizable indirect effect to the plan. At the moment, banks in the United States seem to need a capital injection. The $215 billion not spent will be saved and the savings will be held in ordinary bank accounts.
As a result, the tax cut will act simultaneously to stimulate consumption and to recapitalize the banks. And, this recapitalization plan is controlled by U.S. households. Banks will have to compete for the money (they have to compensate households for the injection) and any bank that households deem unworthy will not get the injection.
This plan will not end the recession. We are only talking about a 1 to 1.5 percentage point boost to GDP growth at most. Nevertheless, it is the best stimulus idea Obama (or Bush) has put forward. I think this plan already has support on the Hill, but let me add my two cents: pass this part of the stimulus now!
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