President-elect Obama announced on January 8 that he is planning to use $300 billion of his $700 billion two-year stimulus package for tax cuts—but we should not celebrate too soon. Obama is proposing a series of temporary tax cuts, not permanent cuts that would hasten economic recovery.
For two years only, Obama wants to give a tax cut of $500 a year to individuals and $1,000 a year to families, at a cost of about $145 billion over the two years. Rather than mail out U.S. Treasury checks, as was done last spring in an effort to ward off a recession, he would lower withholding rates so that the tax cut would be spread over the year.
Obama and his advisers evidently believe that a temporary tax cut spread out over 52 weeks would induce more extra spending than one delivered all at once. The problem is that tax cuts that are temporary have limited effects on spending behavior. Milton Friedman won a Nobel Prize for his permanent income hypothesis, which showed that spending decisions are made not by the amount of money in consumers’ pockets, but by their expectations of future income.
Businesses with losses in 2008 or 2009 would also receive temporary tax cuts. They would be allowed to convert those losses to cash by applying them to taxes paid in earlier years. Treasury checks for the losses would give them additional cash for new investments.