The Congressional Budget Office has concluded in a new report that a fiscal stimulus package should be "timely, targeted and temporary", and should be used to inject dollars into the economy as quickly as possible.
The report, requested by House Budget Committee Chairman John Spratt and Senate Budget Committee Chairman Kent Conrad, suggested that there is "a strong possibility" of at least a few quarters of very slow growth, and that while the economy may avoid a recession in 2008, the risk of a recession has risen. However, it warned that Congress would have to act "almost immediately" for these measures to be effective.
To help avoid an economic slowdown and possible recession, the CBO, a non-partisan arm of Congress, concluded that: "The most effective types of fiscal stimulus (delivered either through tax cuts or increased spending on transfer payments) are those that direct money to people who are most likely to quickly spend the bulk of any additional funds provided to them."
However, in advocating these measures, the CBO dismissed business-related tax incentives, such as corporate tax cuts, as less effective, because they tended to have a less immediate effect on investment and consumption.
"This approach is not a particularly cost-effective method of stimulating business spending," it argued. "Increasing the after-tax income of businesses typically does not create an incentive for them to spend more on labor or to produce more, because production depends on the ability to sell output."
The report also pointed out that "a substantial effect of reducing current corporate tax rates is to increase the returns from past investments rather than increase the attractiveness of new investments".
"Even business tax reductions focused on new investment, however, may have only a limited effect on decisions to invest," the CBO noted. "For one thing, they may apply to investment that would have been undertaken anyway. In addition, like general business tax cuts, their stimulative effect depends on firms’ having tax liability in the first place; without such liability, tax cuts generate no cost reductions for firms."
Share of investment among firms subject to the corporate income tax ranged over the past few years from a little less than 30% to more than 45%, the report observed, citing recent studies in the area.
The CBO's conclusions have been welcomed by leading Democrats, some of whom are proposing just such a course of action to avert an economic crisis.
"As Congress begins to consider options for a fiscal stimulus package, CBO’s report will provide a useful set of guidelines for evaluating the potential effectiveness of possible stimulus measures," Kent Conrad, a North Dakota Democrat stated in response to the recommendations.
"It should be focused on the middle class and others who are most likely to spend whatever benefit they receive and generate new economic activity. And it should be temporary, so that our long-term budget outlook is not worsened," he concluded.
The full text of the CBO fiscal stimulus report can be found in the Tax News Resources section.
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