Treasury Secretary Paul O'Neill and Boston Fed President Cathy Minehan have been telling us that the check is in the mail. Once everybody receives a few hundred of their own dollars back from Leviathan, the economy will come roaring back. We’ll carry on with a productivity-driven market rally, while the Baby Boomers can resume planning for their retirement cruises instead of fretting about having to line up for senior-citizen discounts down at Kmart.
Getting something back from the government is such an obvious benefit, and taxes are such an economic and social evil, that, in the celebration of the moment, we may all have fallen into the pit of shoddy thinking. Economics is not an occult science (honestly!), but we do have to trust our own reasoning as we make the extra effort to peer through Bastiat's window and trace the consequences of our actions until all the ripples that spread outward from them die away on the pond.
Consider a constitutional government that can only raise funds honestly by taxing and by borrowing from productive private citizens—after seeking their approval to do so. Assume that those citizens freely choose to place all of their savings at the disposal of that government by buying its bonds. (This last is not critical to the argument, but it does avoid distractions.)
As members of the private sector trade with each other, one man's income is another's expenditure, with the only escape from this loop being the exactions due the tax collector and the savings each voluntarily makes. What does government do with the money it gathers in? It spends it, of course, providing an income for its drones, and bribing its supporters, and promoting whatever misplaced social engineering programs it wishes, but spending it nonetheless, on goods made and services rendered, in large part, in the private sector.
It should be clear that it is a bad thing for a free people to give up command over the over the means of production and for these means to be diverted to serve the needs of central government planners (of whichever party). Any reduction of their influence not only promotes prosperity but also enhances liberty. For this, Bush and O'Neill are to be applauded, however small the step they are taking.
Here, though, we are here concerned with the question of a short-run economic stimulus, and this is a different issue entirely. If a government should find itself in the felicitous position of receiving more revenue than it has existing plans to disperse, it must render up the difference in some fashion.
Assuming it does not simply increase its share of total spending, it can either retire debt or cut taxes. Economically, these effects are neutral: either the public recovers its funds in its capacity as income earner or as (redeemed) bondholder. True, different sets of people benefit from the payment, but isn't that what government is about anyway, diverting resources to one group at the expense of another?
Ah, you say, but bondholders are savers and taxpayers are spenders, and the economy needs consumption right now. Well, actually this is incorrect: There is no "paradox of thrift." The late Bubble has wasted a vast amount of capital and so thereby has reduced—yes, reduced—its potential productivity. To rebuild this, we need to augment savings and lighten up on the instant gratification a little.
What happens to any savings that do arise? It is just conceivable that U.S. citizens will hoard. Yes, they could just withdraw $1.2 trillion dollars over ten years in banknotes and stick it under their mattresses. But it is much more likely that, rather than enduring an increasingly uncomfortable night's sleep, the funds will go on deposit, or into a mutual fund, or into the bond or stock market. There, they will be available for someone else to spend instead— maybe those poor, spendthrift income earners who didn't get the bounty from the IRS directly, or maybe a fledgling company wishing to make an ultimately productive investment.
In other words, the money government takes from us—"us" in the sense of the Borg Collective, which is how the State thinks of us—it gives back in some fashion: it spends it, it buys back its bonds, or it returns it in a check to its reluctant tributaries.
How, then, can a mere change in the method of this disbursement provide an aggregate stimulus? It might help McDonald's rather than McDonnell–Douglas, Wal-Mart instead of Wall Street, or FedEx rather than the Fed—but all this is simply another case of a Peter-and-Paul transfer payment, not an outright booster.
Finally, there is one complication with which we must deal. Real-world government has a third source of revenue: inflation,—that most antidemocratic of taxes. Now it has been a long time since the Treasury did this by shaving its coinage (you try reselling a clipping from a $1 bill when the whole dang thing doesn't buy a gallon of gas). But it has a neat, indirect trick: It gets the Fed, or its member banks, to conjure up the money for it out of thin air, issuing them a bond instead. No pain, and lots of gain all round. Government has the limits on its powers largely removed, and the banks earn interest on, well, on nothing, actually.
Now, if the government were to use its tax surplus to get its bills and bonds back from the banks, potentially this could be deflationary. The government has repaid a loan, and the bank—losing both asset (Treasury bills) and liability (someone's deposit account, somewhere, from whom the government expropriated the money)—contracts its balance sheet. Money supply goes down and prices could, in the end, follow. So much for the theory! Just check the reports and see if you can find an instance of money supply (broadly defined), or of the balance sheets of the Fed or the commercial banks going down. No, we thought not—not since the last recession, at least, and even then it was not fiscal policy which occasioned it, but the legacy of the disastrous lending practices in the previous boom.
Rather, the banks have simply either written new replacement loans to willing private-sector borrowers, or granted credit to those monstrous quasi-governmental agencies so they can interfere even more with the free market in real estate. Lower taxes leave more resources in the hands of those who generate wealth, not welfare, and give rise to prosperity, but you should expect the imminent tax rebate to act as a lubricant—not as a fuel—in the sputtering economic engine.
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