Tax Rebates Are a Losing Proposition Part 1

The following commentary is from Marotta Asset Management and expresses their views on the current economic stimulus package being given to many taxpayers. I'm sure you all will love it. ;-)

Beginning this month until July, the government will issue over $100 billion in tax-stimulus checks, the equivalent of about 1% of annual consumer spending and some 70% of the country's $14 trillion gross domestic product (GDP). The assumption is that we can spend our way out of a recession by boosting third-quarter GDP growth over 4%.

More than 130 million households will receive $600 per adult plus $300 per child with a family of four receiving $1,800. But for taxpayers with an adjusted gross income of $75,000 ($150,000 filing jointly), who paid more than 60% of all taxes, these amounts are either reduced or eliminated. In contrast, many people who never file a tax return or pay any taxes will receive the full amount. The government has created special forms and public relations campaigns specifically to reach this group and encourage them to file and enjoy a rebate of taxes they never paid.

If I am elected president, I won't insult the public like this. Tax rebate stimulus checks are a cheap and inefficient gimmick that will increase the fragility of our economy and impoverish those who receive such checks.

You can't spend your way out of economic trouble as a country any more than you can lift yourself personally by pulling on your shoestrings. Increased spending is an indicator of economic health only when it is preceded by increased production and earnings. Rich people generally spend more, but it certainly is not what makes them rich.

It would be much better if we as a country tried to save and invest our way out of a recession. Imagine if everyone invested their rebate by creating new businesses or building factories. Then we as a nation would produce more. Increased annual production could be sold, which would increase our GDP.

Consuming more goods doesn't really help our economy when half the stuff we buy comes from China anyway. In fact, deferred consumption is the definition of capital and would allow us to use that capital to build more productive companies. It would lower unemployment and reduce inflation.

The tax rebate gimmick is extremely inefficient. The legislation itself added hundreds of pages to this year's tax code. The IRS launched a tax rebate information center offering check amount scenarios, along with information especially directed toward Social Security recipients and veterans. The agency was taking more than 50,000 calls per day over their normal tax-season load. Their automated-response phones handled 1.2 million calls specifically about the rebates, and the IRS reassigned 1,500+ employees just to deal with the inquiries.

To be eligible for the $300 rebate, parents had to apply for a Social Security number for their children. People not normally required to file a tax return had to do so to receive their rebate checks. The IRS Free File Alliance was created to provide free services to people who were filing solely to receive their economic stimulus payment.

None of these compliance costs are free. Someone has to be paying for them. Estimates suggest that compliance costs add an additional 50% to the expense of taxation. Because of the added burden of a unique program such as this, the costs are probably higher.

That means those $1,800 checks will probably cost taxpayers about $3,000 each.

The tax rebate gimmick impacts negatively on our economy. Economic systems change gradually and operate best in stable conditions. Only when goods and services are free to be used wherever they are deemed most valuable does economic growth have the best chance.

But rather than trust in the free markets, President Bush and Congress have tried to boost consumer spending artificially without any reduction of federal spending, thus increasing the money supply and fueling inflation. More dollars chasing static production is the definition of inflation. Many families earning $36,000 a year will receive a $1,800 rebate check representing an additional 5% bonus, only to find that prices on their purchases are 5% higher. Thinking they are better off, they will actually be poorer if receiving the check increases their spending habits by even a penny.

Every time the government bureaucracy engages in centralized spending plans, the economy is weakened. Free markets are the best method of self-rationing scarce resources to where they will do the most good. Every time the government tries to solve an economic problem via fiat, they can only do worse than the efficiencies of the market itself. By trying to strengthen or bail out one section of the economy, they slightly weaken and destabilize all the others.

Finally, the tax rebate gimmick will impoverish those who receive such checks. In polls, most Americans claim they will put the rebate in savings or use it to pay down debt, but behavioral finance research suggests otherwise.

Studies have shown that even the most rational of consumers who receive money spend more as a result. Surprisingly, when they receive relatively small amounts, they justify additional spending by more than 2.5 times the size of the original check. The psychology behind this thinking is so strong, it is safe to assume we are all influenced by it.

We see evidence that the effect is universal when we hear people say they will save the rebate or use it to pay down debt. The fact that they are thinking of the money from the rebate as though it were different from the rest of their budget means they are already engaging in the two-pocket fallacy of money, thinking of money differently simply because of the source.

Perhaps they will pay off some of their debt, but they did that the month before they got the check. Perhaps they will put money into their 401(k), but that happens automatically. Because these rebate checks will continue to be featured in the media for months as they dribble out, they will continue to be in the forefront of our minds. Someone will complain about a delayed check while other coworkers share what they've already purchased. And most Americans will use the idea they have some extra money to justify a purchase they would not otherwise have made, probably more than once.

In fact, studies suggest that average consumers will spend an additional $4,500 in relatively small purchases simply because they received a $1,800 check: an extra $45 eating out, a $90 electronic toy, and a $650 appliance. Children will be given their $300 as though it somehow belongs to them, and husbands and wives will use the money as an excuse to make that purchase their partner considers frivolous. Without even realizing it, past studies suggest consumers will spend 250% of their rebate check.

In polls, American claim they will spend only 18% to 40% of the rebate. But in reality, anyone who spends more than 4% will actually lose ground in saving toward their retirement. Next week's article will explain the realities of this scenario. Until then, don't spend a penny of those rebate checks.

Comments

[JeffrO]

Already used mine to payoff a small personal loan, two small medical bills, and two small, deferred car repairs. My $2,100 is gone...

Sorry G.W. Bush -- no new appliances, big screens, Wii's or autos in this family. Blame me for the long protracted recession if you'd like, but I've got a family of 5 to feed and transport.

I agree that this "economic incentive" is a farce. It is a house built on sand and will get washed out to sea with the next one or two high tides. When are we going to start seeing the Gov't and Business News start reporting Consumer Savings instead of Consumer Spending as an indicator of our country's economic health (unhealth?). Guess what, nobody wants to hear that the news is bad....very bad.

[Cytoman]

The economic stimilus package is nothing more than a vote buying scheme for politicians who want to be voted back into office by people who don't understand basic economics.

[Kirk]

Agree with Cytoman.

As far as a rebate, this is nothing of the sort. A true rebate means the provider returns a portion of the revenue to the customer. The government isn't rebating. They are just adding debt.

[theantagonizer]

our new HD video camera is pretty nice.

[rob]

It is what it is. All I can say is, thanks for the help in paying down our mortgage! Btw...our paper check has yet to arrive...bummer! Hurry up already.

[kitty]

Agree with the original post and Cytoman - it is just a gimmick to show us that the government is "doing something". Granted, I am not exactly objective because I am not getting anything. As the original poster correctly said, those of us who pay more in taxes get exactly nothing.

I don't mind that I am not getting it since it wouldn't have made much of a difference in my budget, but I do mind the total amount of money that is spent on it. Starting with the ridiculous 50-something million wasted on sending everyone a letter telling us about the rebate. I wonder how much more waste is there in just processing the rebate. If I had believed for a moment that it would help the economy I'd be all for it, but I just don't see how it could for all the reasons stated above.

[NR]

Thanks, whatever you may call it, now I can pay my bills to NW Hospital. I may have the courage again for another check up.

[Brett]

Gosh, I never knew letting people keep more of their own hard earned money would get ire up of so many financial types. I think it's a good thing when people keep more of thier own money instead of the government over burdening people with excess taxation.

[Tianen]

My daughter dindn't receive the extra money for her two children ,she only r ecived $600. Why she didn't get the full amt. of $1800? The government took my check for taxas that I owe. I am on payment plan for last year 2006. Why did theyl take my money. I haaven't gotten the bill for last year yet, thely took my rebate check. For the amt. I owe. Why?

[Colin]

"None of these compliance costs are free. Someone has to be paying for them. Estimates suggest that compliance costs add an additional 50% to the expense of taxation. Because of the added burden of a unique program such as this, the costs are probably higher.

That means those $1,800 checks will probably cost taxpayers about $3,000 each."

I found this statement kind of dubious. For the government to send out $1800 checks, it costs $1200? OK, postage is $0.41. You have the IRS call centers and information campaigns, but the vast majority of taxpayers don't require these services.

Using the $100B in payouts, and the above 67% (1200/1800) cost, that implies that it will cost the government $67B to implement the program. From what I found online, it looks like the entire IRS budget is $12 billion.

http://www.gao.gov/new.items/d07719t.pdf

This kind of looseness with the numbers makes it look like Marotta just has a bone to pick, and makes it hard for me to take the rest of the piece seriously.

[FMF]

Brett --

That's an interesting point of view. What about all the people that paid taxes that didn't get a rebate? And what about all those who didn't pay anything and did get one? Is this really people getting their own money back?

[Rick]

If the government really wanted to let taxpayers keep their own hard-earned money, it would lower taxes (and of course, lower spending to match).

[Jake]

"This kind of looseness with the numbers makes it look like Marotta just has a bone to pick, and makes it hard for me to take the rest of the piece seriously."

I am shocked, shocked!

Marotta's articles chronically make the mistake of starting with a viewpoint and then trying to make the numbers fit the viewpoint. Examples:
-- saying T-Bills are more risky than small cap emerging markets mining companies, and then changing the definition of "risk" to make it so.
-- pretending like inflation and exchange rates are the same thing in order to discredit CPI inflation numbers.
-- deciding that Democrats' regulations passed in the 1970s and 1990s created the subprime crisis, and ignoring numbers like volume of subprime issuance spiking in 2005-2007 because they didn't "fit".

And now it cost the government $1200 to mail me a check, on top of the money that I'm getting from said check?

"Consuming more goods doesn't really help our economy when half the stuff we buy comes from China anyway."

Worth noting that only 16% of our imports actually come from China, and that the USA's total value of imports was less than $2bn in 2007, which is less than 1/7 of US GDP. So about 2.28% of what we buy comes from China, while ~85.7% of it is produced in America. Inconvenient numbers.

"Estimates suggest that compliance costs add an additional 50% to the expense of taxation."

This is simply inaccurate. Actually, it's grossly inaccurate. Even www.fairtax.org, a website arguing for the virtual abolition of the IRS based on its inefficiency, estimates compliance costs at 10%-24%. Given the bias of the source, I think we can safely assume that the lower end of the range is more correct than the higher end. But when the numbers aren't convenient, why not just make some other numbers up out of thin air??

http://www.fairtax.org/PDF/WhatTheFederalTaxSystemIsCostingYou.pdf

[Jim]

I agree the stimulus refund its mostly a gimmick and largely the politicians just bribing us for votes. I don't think its completely ineffective though as any increased spending will help stimulate the economy to some degree. Its not an efficient way to do so though.

However, the numbers presented to support the arguments in the article are just plain wrong and very poorly presented with no sources or substantiation. Colin rightly pointed out that the IRS's total spending is not nearly high enough to support an argument that it costs them $1200 extra to send us a $1800 check. For the article to make such a claim seems extremely ignorant of the real facts and is just plain misleading.

Jim