Student Reading
For months now, the American economy has shown signs of slowing down. Stalling GDP, weak holiday retail sales, lower housing starts, rising interest rates, and higher unemployment are all indications that “something’s up” and the economy is down. Recently journalists and politicians have begun to use the dreaded “R word” – recession. Many fear that “recessionary psychology” is taking hold and that consumers will begin to react by spending less, initiating a downward spiral in which decreased spending (demand) reduces employment and income, which in turn further reduces spending. Such negative momentum could turn the fear of a recession into reality. Knowing that gloomy recession headlines trigger finger pointing that’s not good for political careers, politicians have a strong incentive to address recessionary psychology. Enter: the economic stimulus act of 2008!
At this point we should take a moment to deal with the term “recession” since it is central to this discussion and lesson. Economists define a recession as a downturn in output (real GDP) for two consecutive quarters. In other words, if the total domestic production of goods and services falls for two three-month periods in a row, then the economy is officially in a recession. Producers don’t generally have to wait for the announcement to figure it out, however. Business owners know when orders and sales slow down. Plumbers get fewer late night and weekend calls as homeowners make do or become do-it-yourselfers. Restaurant owners see fewer customers, or even empty tables at peak times, and waiters’ tips shrink, too. Local store owners count fewer dollars going through the cash registers as fewer products go out the door. When customers buy less, businesses cut prices and order less from their suppliers. As business falls off, workers' hours (and sometimes wages) are cut, and if the slowdown continues, some workers are laid off. As wages and employment begin to feel the impact of the slowdown, consumers don’t need an official declaration of recession either. They change their behavior in response to lower wages, the threat of unemployment, or just the uncertainty of the future.
While we’re usually most aware of the impact of recessions on workers, it’s important to note that employers aren’t the bad guys here. They’re just responding to the overall lag in demand for their products, and that changes their demand for labor – which is why economists classify the demand for labor as “derived demand.” The demand for workers is derived from the demand for the goods and services the workers produce, and if the demand for those products falls, then so does the demand for workers. You get the picture – and the picture gets uglier, because these workers are also consumers, moms, dads, retirees, college students, and even high school kids. As their hours (and thus their pay) are cut and as some face lay-offs, they have less money to buy the goods and services that producers are making. They worry about paying their bills and begin to cut back on eating out, vacations, home improvements, clothes, appliances, and, if the recession is bad enough, even on every day purchases like gasoline.
So, when you hear that the economy is “slowing down” or “turning down,” what’s really happening is that people are generally spending less and unemployment is rising, and this process can easily gain negative momentum. If the downward spiral of a recession isn’t stopped, the economic situation can deteriorate quickly and even exponentially. This is why President Bush and his team of economic advisors decided that action was necessary.
In his State of the Union Address in January, President Bush asked Congress for legislation designed to stimulate the economy. The result was the recently enacted “Economic Stimulus Act of 2008.” So what’s it all about? The stimulus package has three components: tax rebates, some incentives for business investment spending, and relief for some types of large home mortgages.
Before you look at the highlights and some experts’ comments about the package, read back through the description of a recessionary downturn. Note that a big factor in a recession is a slowdown in consumer spending. One way to reverse the process that leads to business slowdown and reduced employment and income is to get consumers and investors spending again. Most of the stimulus package, about $120 billion of the $152 billion that was included, was dedicated to tax rebates in hopes that they would spur consumer spending. With that in mind, review the elements of the stimulus package listed below and read the series of analyses excerpted from news reports on the legislation. Then consider what the economic stimulus plan is supposed to do and how it’s supposed to work before coming to your own conclusions about whether it will.
Highlights of HR5140, Economic Stimulus Act of 2008:
- Most working citizens of the U.S. will receive $600 if single or $1,200 if they file a joint return and paid at least that amount to the IRS in income taxes last year. A $300 rebate will be paid for each child claimed as a dependant.
- Those with at least $3,000 in income derived from employment, Social Security, and/or certain veterans’ benefits will get $300 or twice that amount if married and filing jointly, whether they owe tax or not.
- The rebate will be reduced for those with children by 5% for every $1,000 of income over $75,000 for single persons and over $150,000 for couples filing jointly.
- Single persons with $87,000 or more in gross income and couples with over $174,000 of gross income and no children will receive no rebate.
- Only those with valid Social Security numbers are eligible to receive rebates.
- Those claimed as dependents on someone else’s tax return receive no money.
- Checks could be in the hands of taxpayers by May of this year
- Depreciation of capital equipment that business investors can deduct from their taxes has been increased for 2008.
- The size of home mortgage loans covered by “Fannie Mae” and “Freddie Mac” government loan programs has been increased.
- (See http://thomas.loc.gov/cgi-bin/bdquery/z?d110:HR05140:@@@D&summ2=2& for more details.)
Expert and Media Analyses
While the purpose of the tax rebates is to encourage spending, there are no guarantees. It’s like the old saying that “You can lead a horse to water, but you can’t make him drink.” Therefore, much of the analysis and commentary on the stimulus package centers on speculation about whether or not the rebates will be spent and if they are, on what.
Economists Dissect Economic Stimulus Package (Dallas Morning News, Jan.25, 2008, wire reports)
At the center of the plan is an effort to spur consumers, whose spending makes up 70 percent of the American economy. The plan leans heavily on cash payments for all but the wealthiest Americans, assuming that money put in pockets will swiftly find its way into cash registers, generating jobs at restaurants, retail outlets and banks and on the factory floor.
. . . Seven years ago, the last time the government handed out rebate checks in a downturn, recipients spent two-thirds of the money within six months, according to Mark Zandi, chief economist at Moody’s Economy.com. This time, unlike the last, some of the money is going to people who do not pay income taxes, so an even bigger surge of spending is likely, he said.
But much has changed in recent years. Given that a lot of Americans are so deeply in debt, some economists said, many may use the money to pay off bills rather than to buy new goods and services. “People are already behind on mortgages and credit cards.” said Gary A Hoover, an economist at the University of Alabama.
SOURCE LINK
Bush signs stimulus bill; rebate checks expected in May (CNN.com, Feb. 13, 2008 wire report)
Economists generally agree that the economy should see a boost from the rebate checks. But most also agree that the full impact will be less than the total value of the stimulus package.
That’s because some recipients are expected to save their rebates or use them to pay down credit cards or other debt instead of spending it. In addition, some consumers may spend their rebates on imported items, which would provide a more limited lift to the U.S. economy.
“My guess is that of the $10 billion to $120 billion of tax rebates, about half will go to U.S. products and services, “said David Wyss, chief economist for Standard & Poor’s.
http://www.cnn.com/2008/POLITICS/02/13/bush.stimulus/#cnnSTCText
Winners and Losers of the Stimulus Package ( Fox Business, Thursday, Jan.24 2008, Mark Lieberman)
Some of the controversy surrounding the stimulus package focuses on what did not make it into the final bill. Many believe that not enough money was directed to low income individuals and families who are perhaps the most likely to spend the money and stimulate the economy.
. . . Part of the debate over the tax rebate is whether it will work to encourage consumer spending. The Congressional Budget Office reviewed the history of tax rebates in a report issued last week.
“Most studies of purely temporary, one-time changes in taxes have suggested that they have only a moderate effect on household consumption,” the CBO said, noting studies of a rebate issued in 1975 “suggested that only 12% to 24% of the rebate was consumed in the quarter that it was received.”
CBO said though “the experience of the 2001 tax rebate appears to differ from the findings of these earlier studies.” CBO noted the 2001 rebate was part of a broader tax package which lowered tax rates and applied those reductions retroactively. In 2001, most households received rebate checks of either $300 or $600 from late July 2001 to the end of September 2001 during a recession.
“Most analysts agree that the 2001 rebate stimulated the economy,” CBO said, “although there is some debate as to the magnitude of the effect.” Households, according to one study, spent between 20% and 40% of their rebate amount in the quarter in which the rebate was received .
Other researchers using credit card data, found spending increased by about 40% of the rebate on average. The study also found that consumption rose the most for consumers who had credit problems but those with strong credit responded to the rebate by paying down their debt.
A third study cited by CBO found only about 22% of households surveyed said the 2001 rebate would lead them to “mostly increase spending,” as opposed to mostly saving it or paying down debt, suggesting banks and credit card lenders will benefit.
SOURCE LINK
Economists Dissect Economic Stimulus Package (Dallas Morning News, Jan.25, 2008, wire reports)
. . . [T]he way the deal was cut left many bemoaning the compromises. Democrats had sought the extension of unemployment benefits and an increase in food stamps. Research shows these measures deliver the largest increases in spending, because poor people are prone to buy what they need when given the chance. Wealthy people, by contrast, tend to save more when taxes are cut. The Bush administration insisted on rebates alone, and House Democrats relented in exchange for adding payments to people who do not pay income taxes.
“They gave up pieces of the package that were more effective,” said Jared Bernstein, senior economist at the labor-oriented Economic Policy Institute in Washington. . . .’ “
SOURCE LINK
CBPP Statement For Immediate Release (Center on Budget and Policy Priorities, Thursday, January24, 2008)
. . . Although the package includes a reasonably designed tax rebate, the two most targeted and economically effective measures under consideration – a temporary extension of unemployment benefits and temporary boost in food stamp benefits – were zeroed out. . . .
The two respected institutions that have rated the stimulus options in recent days – the Congressional Budget Office and Moody’s Economy .com – both give their two highest ratings for effectiveness as stimulus to the two measures that were dropped. www./cbpp.org/1-24-08bud-stmt.htm.
Discussion Questions:
- Summarize: Who will receive checks later this spring and how big will the checks be?
- If you were to get the $300 rebate for dependents, what would you do with it?
- What do you think most people your age would do? (Hint: some of these folks are sitting right next to you!)
- What do you think your parents will do with the rebate they receive? Look back at the articles. Based on your knowledge of your family’s situation, find what the experts predict your parents will do. Do you think the experts are right? Explain.
- What do the drafters of the plan hope will happen to overall demand for consumer goods? If the hoped-for results occur, who will benefit most from the economic stimulus?
- Why did Congress decide that some people will receive higher rebates than others and some will receive nothing at all? Explain the reasoning of those who support and those who oppose this distribution scheme.
- Summarize the argument of those who think that the stimulus should have included higher food stamp allowances and extended unemployment benefits. Does your experience with people’s spending habits (including your own!) support or contradict this reasoning? Explain.
- Predict: Do you believe that the Stimulus Package of 2008 will produce the desired results? Quote from the excerpts in the reading to support your reasoning.
- What’s the opportunity cost of the stimulus package?
- Who bears that opportunity cost?
- What would have to happen for the benefits of the stimulus plan to exceed this cost?
- How will we be able to tell if it has?
- What would have been the opportunity cost of not passing a stimulus package?
- Who would have borne that cost?
- Since the package was enacted, Congress must believe the opportunity cost on not passing it was too high to bear. Do you? Explain.
- (optional) Extension Question - Illustrate your answer to question #3 with a supply and demand graph, showing demand before (DB) and demand after (DA) the stimulus.
Teacher Guide
- Summarize: Who will receive checks later this spring and how big will the checks be?
- Most adult U.S. citizens (approximately 130 million) will get $600 to $1,200 depending upon their marital status, plus $300 per dependent child.
- The amount will be gradually reduced for single people earning over $75,000 and married couples earning over $150,000.
- Those who earn at least $3,000 from a job, social security, or certain veteran’s payments will get $300 ($600 if married). Point out, if students don’t, that those who have a job but make less than $3000 (and are not dependents as most teenagers are) get nothing from this plan. Most will understand why those with higher incomes may get nothing, but be puzzled that the same is true for those on the other end. One possible explanation is that people on this end of the spectrum are already benefiting from government assistance programs. As mentioned in the guide to question 4, below, there are also practical problems in getting rebates to people without social security numbers, jobs, and permanent addresses.
- If you’re single and make more than $87k or if you’re married and earn more than $174k; you’re out of luck.
- If you were to get the $300 rebate for dependents, what would you do with it?
- What do you think most people your age would do? (Hint: some of these folks are sitting right next to you!)
- What do you think your parents will do with the rebate they receive? Look back at the articles. Based on your knowledge of your family’s situation, find what the experts predict your parents will do. Do you think the experts are right? Explain.
- Answers from students will vary, but anticipate that for some, the answer will be a combination of spend and save, rather than all of one or the other. Point out that when the excerpts refer to a % of spending or saving, they’re not referring to the number of people or implying that people either spent or saved all of their rebates.
- Before students respond to, “what would most people your age do?” ask them to write down their predictions and then ask those around them for their response.
- You may want to ask about the comment in the CNN article that points out that expenditures on imported goods could diminish the lift that spending could give the U.S. economy and ask if the student spending would be on imported or domestic goods.
- Think ahead about whether to include the question about what students think their families will do. Be sensitive to the range of income levels and the possibility of students being uncomfortable discussing this question. An alternative is to focus on the predictions and frame the question generally: What do the experts predict that families in our community will do with their rebates? Do you agree with their predictions? Why or why not?
- What do the drafters of the plan hope will happen to overall demand for consumer goods? If the hoped-for results occur, who will benefit most from the economic stimulus?
The creators of the plan hope that overall demand for consumer goods will increase, stimulate the production of consumer goods and services, and stimulate job growth in those industries. The article indicates that people looking for employment in areas like restaurants, retail sales, and factories – the lower ends of the wage range – will benefit.
- Why did Congress decide that some people will receive higher rebates than others and some will receive nothing at all? Explain the reasoning of those who support and those who oppose this distribution scheme.
Students may start here with “the wealthy,” arguing that rich people don’t “need” the additional money. Without getting too sidetracked, you may mention that both need and wealth are relative terms and that the dividing line between rich and poor is not really that easily defined in concrete terms. Economists and politicians struggle with this and that’s part of the reason that this plan seems “broad in the middle.” The political reality of who was and was not targeted in this plan has something to do with poverty (helping those most deserving of assistance) and something to do with winning voters in an election year, but it also has to do with what people at different income levels do with additional income at the margin. The basic idea here is that marginal propensity to consume is greater at low incomes and marginal propensity to save is greater at high incomes. Getting people to spend is essential to this plan and students should be reminded of that. Students will likely struggle most with why people on the lowest end of the economic spectrum will get nothing or will simply get a “flat” amount from this plan. Again, there are both practical and political considerations here:
- Getting money into the hands of people who don’t have social security numbers and permanent addresses is tough and it’s politically unpopular.
- Quick action was considered necessary from an economic standpoint and from a political one as well.
- Summarize the argument of those who think that the stimulus should have included higher food stamp allowances and extended unemployment benefits. Does your experience with people’s spending habits (including your own!) support or contradict this reasoning? Explain.
The issue of what was left out is an important one. Certainly if the goal is to help the poorest of the poor in the U.S. then increases in food stamps and the extension of unemployment benefits would seem to make sense. However, both of these programs would take considerable time to implement and as was pointed out in the previous answer, and commented on by the analysts, quick action was a priority of the President and Congress.
- Predict: Do you believe that the Stimulus Package of 2008 will produce the desired results? Quote from the excerpts in the reading to support your reasoning.
Anticipate a variety of answers, but insist that students support their predictions with consistent quotes from the reading. Draw attention to quotes referencing the history of similar plans. You might also ask students to consider whether or not their opinions were altered by the class discussion.
- Given that permanent tax cuts were not considered to be the next-best alternative, the opportunity cost of the stimulus package is the next best use of the $152 billion dollars of government spending. While we don't know for certain what that would be, likely candidates include a reduction in the predicted deficit, or expenditures on the war in Iraq or on education or other social programs favored by the Bush administration and Congress. The important point here is that the $152 billion represents something else that could have been done—the package had an opportunity cost associated with it.
- The question of who bears that cost is tougher as it is not clear who will be directly impacted by lower government spending – recipients of social programs? education? soldiers in Iraq? – or by a higher deficit – borrowers paying higher interest rates? Investors?.
- For the benefits of the stimulus plan to exceed the costs, it would have to work! From a practical economic perspective, we would have to see a diminishing of recessionary pressures through increases in spending and job growth, for example. From a political perspective, polls will tell us whether citizens are satisfied with the actions of Congress and the President.
- What’s the opportunity cost of the stimulus package?
- Who bears that opportunity cost?
- What would have to happen for the benefits of the stimulus plan to exceed this cost?
- How will we be able to tell if it has?
Given that permanent tax cuts were not considered to be the next-best alternative, the opportunity cost of the stimulus package is the next best use of the $152 billion dollars of government spending. While we don't for certain what that would be, likely candidates include a reduction in the predicted deficit, or expenditures on the war in Iraq or on education or other social programs favored by the Bush administration and Congress. The important point here is that the $152 billion represents something else that could have been done—the package had an opportunity cost associated with it.
The question of who bears that cost is tougher as it is not clear who will be directly impacted by lower government spending – recipients of social programs? education? soldiers in Iraq? – or by a higher deficit – borrowers paying higher interest rates? Investors?
For the benefits of the stimulus plan to exceed the costs, it would have to work! From a practical economic perspective, we would have to see a diminishing of recessionary pressures through increases in spending and job growth, for example. From a political perspective, polls will tell us whether citizens are satisfied with the actions of Congress and the President.
- What would have been the opportunity cost of not passing a stimulus package?
- Who would have borne that cost?
- Since the package was enacted, Congress must believe the opportunity cost on not passing it was too high to bear. Do you? Explain.
- The opportunity cost of not passing the stimulus package would have been giving up all of the benefits expected to result from the stimulus. We do not yet know if those benefits will materialize so we don’t yet know if Congress and the President accurately anticipated the opportunity cost of not passing the package. Choices are always made on the basis of anticipated benefits and costs, and we know that Congress and the President anticipated that the cost of not passing the stimulus was an increased chance of recession and political discontent if citizens perceived government as unsympathetic to their economic hardship.
- (optional) Extension Question - Illustrate your answer to question #3 with a supply and demand graph, showing demand before (DB) and demand after (DA) the stimulus.
Increased demand will increase prices and quantity supplied. Students may also include a second graph, showing that the derived demand for labor would also increase, result in more jobs (QSAfter) at higher wages (WAfter).
Increased Demand for Consumer Goods
