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A Supply Side Approach to the Crisis
Yesterday I pointed out that credit is still robust. Growth rates are declining, however, and many people say the real crunch is around the corner. Thus, today I want to suggest a new approach to dealing with the crisis that will have benefits regardless of how the crisis unfolds.
I see the key issue as follows: Banks bridge the gap between savers and firms. We want to keep capital flowing to firms even when some of the bridges collapse. One approach tries to prop up the collapsed bridges, a second approach tries to route funds across substitute bridges. A third approach is to increase the flow pressure - in other words, I suggest a temporary but large stimulus to savings.
I suggest that for the next 12 months contributions to an IRA account will never be taxed. We can modify this in various ways to cap contributions at a certain level etc. We can even make the proposal progressive - for the next 12 months contributions to an IRA account will never be taxed and the government will match $1 for every $10 saved for anyone with income below a certain threshold. The main idea is to increase savings.
The increase in savings will help deal with our current problems by offsetting any credit crunch. (Some of the savings will also help to recapitalize banks.) In addition, the U.S. needs a higher savings rate regardless. During the 1990s as measured savings rates declined to zero commentators argued that rising asset values compensated. Well asset values are now falling so true savings are negative - thus we need to increased savings.
A big benefit of this proposal - lower taxes, higher savings and a savings bonus to those with lower incomes - is that it should appeal to both the right and the left.
Posted by Alex Tabarrok on September 25, 2008 at 07:33 AM in Current Affairs, Economics | Permalink
Comments
The "saver's credit" already exists. It begins at 50% for up to $2,000 of contributions and is phased out at $26,000 for singles. Check out IRS Form 8880.
As far as the plan to never tax IRA contributions, would you have to open a separate account for these tax-exempt contributions? In a traditional IRA, there'd be no way to tell tax-free gains from taxable gains. Although, you could add yet another line to the 1040 for the next 10 years that deduct Roth contributions from AGI. That way it's deducted today and also not taxed at dispersement.
Posted by: Zach at Sep 25, 2008 8:21:02 AM
I don't like it. You're still increasing the public debt. Let's not solve a problem by exacerbating an existing one.
Posted by: Robert at Sep 25, 2008 8:29:20 AM
I think all other plans increase the public debt. Tax cuts don't cause spending. Besides, you have to kick the dog that's biting you today.
We don't have a consumer spending problem. We seem to have a rolling-over-short-term debt problem. So, considering much of the savings would go into money markets and maybe CDs for first time savers, and the banks would have to do something with it, this seems sound.
Ixnay the welfare check and cut government spending to "pay" for it, and we have a deal.
Posted by: Andrew at Sep 25, 2008 8:34:39 AM
Obviously more savings lowers spending, which exacerbates current recessionary pressures.
The problem does not seem to be inadequate savings so much as the desire for safety and liquidity. More IRA money in short treasuries does not accomplish a lot.
I agree with the first two posters
Posted by: fusion at Sep 25, 2008 8:36:23 AM
Umm ... how well is the economy going to do if we all start suddenly saving more and spending less? Haven't you just concocted a scheme for causing a major economic contraction?
Posted by: at Sep 25, 2008 8:36:45 AM
Real spending has just now dropped, I'll let the economists figure out if this is due to a change in demand or conflated by the petering out of stimulus checks (Thanks gov't for giving us another hand in our economic calculation problem!)
So, again, consumer spending, in my opinion, is not the dog that is biting us today.
Posted by: Andrew at Sep 25, 2008 8:42:24 AM
If its an institutional problem (balance sheets, credibility, confidence) then I'm not sure how this helps. Counties and municipalities in NC (triple A rating) having trouble floating construction bonds even as I write--that will certainly have a real economy impact.
Posted by: Roland Stephen at Sep 25, 2008 8:42:57 AM
If its an institutional problem (balance sheets, credibility, confidence) then I'm not sure how this helps. Counties and municipalities in NC (triple A rating) having trouble floating construction bonds even as I write--that will certainly have a real economy impact.
Posted by: Roland Stephen at Sep 25, 2008 8:44:35 AM
Is now really the time to be exacerbating the paradox of thrift?
Posted by: Bonapart O Cunasa at Sep 25, 2008 9:09:14 AM
I like the idea in theory in that it sort of addresses the problem while attempting to minimize the impact to taxpayers with incentives, but I think it won't fully address the problem.
For one - almost everyone I know has their IRA with Fidelity or some entity like it - e.g. not a commercial bank.
Posted by: meter at Sep 25, 2008 9:11:15 AM
I prefer govt bailing out banks and going down with their debt. Isn't this what we always wanted, drown the govt. It is time to celebrate, not save.
Posted by: Jesus saves America spends at Sep 25, 2008 9:34:45 AM
Zach:
The easiest way to implement this would just be to have Roth IRA contributions be tax-deductible this year.
Posted by: Aric at Sep 25, 2008 9:45:24 AM
FIrst thing: Paradox of Thrift
Second: It's only a temporary solution. It seems to me that there is a lot of adverse selection going on in the financial sector, so a lot of funds will just ignore it entirely and invest in the broader sector (or might even panic and flee the US altogether, figuring recession is right around the corner!). If the financial system doesn't get capitalized but the broader economy gets more savings, it means a reprieve for the broader economy until the financial system.
Most estimates figure we're halfway over, though, so maybe this IS a good plan. By the time the extra savings start flagging, the financial sector will recover.
Another funny:
Will this just cause savings to readjust from the future to the present, or will it actually increase present savings at no cost to future savings? If it's a temporary tax cut, I'll just take some of my contributions from the future and give them to my IRA now...so we're trading off a present problem for a future problem.
Also, I will laugh like all hell if all the increased savings go to purchasing the Treasury Bonds used to fund the crisis. :)
Posted by: Robert Olson at Sep 25, 2008 10:12:22 AM
I kept details out of the post to get at the main idea but Aric is exactly right - making Roth IRA contributions tax-deductible this year would be the easiest way to implement.
The fact that Keynesian economics recommends stimulating consumption, even when the problem is a credit crunch, is a weakness of the Keynesian approach.
Posted by: Alex Tabarrok at Sep 25, 2008 10:12:28 AM
The New York Times [among others] has related taxpayers' anger with CEOs.
I suppose I understand the public's angst over executive pay [although I don't agree with it].
But in what way did corporate executives help "create this mess" as the Times contends?
Doesn't the fault rest solely with borrowers who lied about their ability to pay off debt and the banks who processed their applications? Can someone help me out with this?
Posted by: Stan at Sep 25, 2008 10:45:35 AM
I find it interesting that the total amount of as of June 07 oustanding SBA loans was $685 billion, just $15 billion shy of the consumer mortgage bailout number. If you are looking for another bridge to focus on, why not that?
SBA Study: http://voices.washingtonpost.com/small-business/2008/06/number_of_small_business_loans.html
EconBrowser on entrepreneurial success and access to capital:
http://www.econbrowser.com/archives/2008/09/the_financial_c_1.html
Posted by: Nick Owen at Sep 25, 2008 10:51:00 AM
Alex,
I like it, especially the Roth IRA deduction version. And one big benefit that I don't think anyone above mentioned is that, for it to work, it doesn't depend on putting enormous power in the hands of a lame-duck Treasury secretary who has so much of his own wealth at stake and who can choose to make investments that help him. It also avoids socialism or fascism, or whatever you want to call it, which the current plan doesn't, not a small benefit.
Nicely done.
Best,
David
Posted by: David R. Henderson at Sep 25, 2008 10:53:21 AM
You mean the fallacy of the Paradox of Thrift?
The consumer economy will suffer if consumers suddenly save more, but more capital will flow into productive investment. Perhaps offshore drilling rigs?
Posted by: 8 at Sep 25, 2008 10:55:52 AM
In the last post, some of us were not merely arguing that the real crunch is around the corner; rather, it is upon us now, as of a week or so ago, in a way that is becoming clearer day by day.
Today's datapoint: a chicken-processing company fell sharply (40%) today, because it waited too long to raise capital. Not significant in and of itself, but part of a pitter-patter of raindrops on a tin roof announcing that a downpour has begun and will intensify.
Posted by: at Sep 25, 2008 11:13:57 AM
Contributions to an IRA aren't taxed now. Furthermore, you are building savings long term. That does nothing to solve the short term problem. This isn't much of a solution.
Posted by: Mike Volpe at Sep 25, 2008 11:31:37 AM
While I, as a faithful Roth IRA contributor, like this idea from a personal standpoint, the Roth is hamstrung by a yearly cap on contributions of $5,000. Would you propose raising this as well?
Posted by: Christina at Sep 25, 2008 11:38:15 AM
Credit is still robust? The seven-day rate for asset-backed commercial paper has jumped to 4.5% from the roughly 2.5% rate that prevailed over the past few months. Credit market is imploding as we speak.
Posted by: bill at Sep 25, 2008 12:00:11 PM
How about this for a possible fix:
With Secretary Paulson’s T.A.R.P. plan, the $700 billion used to purchase mortgage backed securities from financial institutions does not guarantee a correction of the four large concerns for our economy - 1) stabilization of the market, 2) improved liquidity for people or businesses, 3) increased investor (both foreign and domestic) confidence in the U.S. economy or 4) payment on the nearly 1.4 million mortgages currently in default in our country.
If there is to be a government sponsored nudge for our economy, perhaps the best way to spend the $700 billion would be to loan the money directly to the homeowners at a fixed, 30-year rate.
That way people get to retain their largest asset and consumer confidence grows, the banks get their money providing an increase in confidence in the banking sector, the investors of the mortgage backed securities get their money and their confidence – along with the confidence of all other foreign and domestic investors – not only stabilizes but increases and the U.S. economy is pulled out of its tailspin.
Posted by: bamboozlde at Sep 25, 2008 12:03:45 PM
Credit is still robust? The seven-day rate for asset-backed commercial paper has jumped to 4.5% from the roughly 2.5% rate that prevailed over the past few months. Credit market is imploding as we speak.
No, it isn't. Look at commercial paper yields and volumes, available at
http://www.federalreserve.gov/releases/cp/
The tables and charts there clearly show that, as of yesterday, nonfinancial firms with good credit quality are not paying much to borrow. Financial firms, especially low-rated ones, and those trying to borrow with asset-backed paper are paying higher rates. Given recent history, that's as you would expect.
Further, the outstandings tables at http://www.federalreserve.gov/releases/cp/outstandings.htm
show that, while there was a drop in nonfinancial commercial paper for the week ended September 17'th, it recovered a bit in the most recent week ending yesterday.
So why the panic? The financial sector has gotten too big and too leveraged over the past few years, and now it is getting smaller. The process isn't pleasant for people in that industry, but there doesn't seem to be much reason for a bailout.
Posted by: Jeff at Sep 25, 2008 12:11:26 PM
You could give the homes to habitat for humanity.
Posted by: floccina at Sep 25, 2008 12:16:26 PM
