Will tax stimulus stimulate investment?

On Monday, the form of potential fiscal stimulus, 2009-style, took a step forward detail-wise. From the Wall Street Journal:

“President-elect Barack Obama and congressional Democrats are crafting a plan to offer about $300 billion of tax cuts to individuals and businesses, a move aimed at attracting Republican support for an economic-stimulus package and prodding companies to create jobs.

“The size of the proposed tax cuts—which would account for about 40% of a stimulus package that could reach $775 billion over two years—is greater than many on both sides of the aisle in Congress had anticipated.”

The plan appears to make concessions to both economic theory—which suggests that consumers will save a relatively large fraction of temporary increases in disposable income—and recent experience—which seems to suggest that what works in theory sometimes works in practice. Again, from the Wall Street Journal:

“Economists of all political stripes widely agree the checks sent out last spring were ineffective in stemming the economic slide, partly because many strapped consumers paid bills or saved the cash rather than spend it. But Obama aides wanted a provision that could get money into consumers’ hands fast, and hope they will be persuaded to spend money this time if the credit is made a permanent feature of the tax code.”

As for the business tax package:

“… a key provision would allow companies to write off huge losses incurred last year, as well as any losses from 2009, to retroactively reduce tax bills dating back five years. Obama aides note that businesses would have been able to claim most of the tax write-offs on future tax returns, and the proposal simply accelerates those write-offs to make them available in the current tax season, when a lack of available credit is leaving many companies short of cash.

“A second provision would entice firms to plow that money back into new investment. The write-offs would be retroactive to expenditures made as of Jan. 1, 2009, to ensure that companies don’t sit on their money until after Congress passes the measure.”

A relevant question here is really quite similar to the one we ask when the tax cuts are aimed at households: Will the extra cash be spent? This graph provides some interesting perspective:


Relative to net worth (of nonfarm nonfinancial corporate businesses), private fixed investment has been in consistent decline since the second quarter of 2006. (The level of fixed investment has declined in each quarter, save one.) In fact, the investment/net worth ratio is currently at a postwar low.

Why? A couple of hypotheses come to mind. (1) Firms are extremely pessimistic about the outlook and see relatively few worthwhile projects in which to commit funds. (2) Credit markets are so impaired that the net worth of firms—a critical variable in mainstream models of the so-called “credit channel” of monetary policy—is supporting increasingly smaller levels of lending. (3) Nonfinancial firms, like financial firms, are deleveraging and hence not expanding.

Of course, even if one of these hypotheses is true, it need not be the case that marginal dollars sent in the direction of businesses will go uninvested. But it makes you wonder.

Originally published at Atlanta Fed’s Macroblog and reproduced here with the author’s permission.

One Response to "Will tax stimulus stimulate investment?"

  1. hsr0601   January 8, 2009 at 8:17 am

    I’ d sugggest two factors for the stimulus project delay; FIRST, the current RECESSION fuel price hinders the progressive investments for Energy Independency / Job Creation. SECONDLY, this progressive investments impede long-lasting earmarks, I guess. But without the job creations and world-wide coordinated efforts, the whole economy can not be activated, I suppose. Now might be the time to recue mainstreet, after the wall street sandbagging,I guess. After the third wave of IT REVOLUTION followed by the immense infrastructure and investments, the fourth wave of ET REVOLUTION awaits a BOLD ACTION for CHANGE, I think. The new govt is on the basis of THE POLICY OF ENERGY INDEPENDENCY adopted by a Democratic Procedure. Americans have chosen CHANGE, and NOTHING ADVENTURED, NOTHING GAINED ! Energy Independency is the unavoidable task ULTIMATELY, and it can also bring down the fuel costs in the long run as a by-product, which might be enormous enough to cover the upgrade investments. All the brilliant brains get together in the U.S. for the better life and future. Lastly, without jobs, the economic activity can’t be activated, and the working class is broke due to the imported fuel costs, therefore the stimulus project by the govt may be in dire need. THANK YOU FOR YOUR CONSIDERATION !