Tax Cuts - Thoughts Before the Budget

Can tax cuts stimulate the economy? Or, to put it better, is the dollar amount of a tax cut a better or worse stimulus than placing that same amount elsewhere? We want to get the most out of the debt our federal parliament seems certain to saddle us with so we should try to get the best possible value. I am watching for this in today's budget announcement.

Of course we all love tax cuts, but they are not always the right answer. Let's consider the recent GST cuts. If these were an effective stimulus we should expect to have seen an increase in economic activity and consequent tax revenue. This doesn't appear to have happened. I say doesn't appear since it is difficult to disentangle the effects of this one item from all the other, sometimes larger, factors affecting the economy and government balance sheets. I am no expert so I will refrain from offering an opinion. All I can do is note that this is being said by many who do have some level of expertise in these matters.

Whether the experts are right or wrong, for the moment let's assume they are right - the GST cuts did not stimulate the economy. Why might that be? If I think about my own behaviour it makes some sense. Frankly, I have not noticed the impact of the GST cuts. A 1% or 2% change in the total cost of my purchases pales in comparison to the price volatility I encounter. Gas prices can shift 10% or more overnight. Some basic foodstuffs have gone up 50% in the past year. A decline of 2% is negligible in this environment. It is invisible. Because it has been outside my notice, it has not altered my purchasing behaviour. I believe the case would be different for high-priced items like cars, but I haven't bought one that recently.

I don't know if my experience is typical so I will avoid generalizing. It does however cause me to wonder what kind of tax cuts would affect me. My guess is that they would have to be taxes that by their very presence, or absence, are impossible to avoid notice. One example would be income tax. We all peruse our paycheques and grimace at the large amounts in the tax box. Should that number go up or down, we immediately notice . Another is capital gains, although it is a minority of the population that directly pays taxes on these. Again, it's right in your face as you fill out your tax return.

I suspect these are the sort of tax cuts that have at least a chance of altering consumer behaviour. The GST cuts are simply too unremarkable and spread too broadly to be very helpful. This is where targeted government-sponsored spending projects are quite different, in that they concentrate capital in selected sectors and regions. This makes them highly visible. The visibility is not always good since, because it is concentrated, there are those who go without the stimulus. Yet even if there is dilution by spreading the capital over many projects country-wide the effects can be considerable since they become newsworthy. That can boost confidence, and therefore spending - initiating an upward spiral. Perhaps this can get us by until the US economy shows signs of recovery.

I am not terribly happy with any stimulus, as I wrote once before in regard to the auto sector. If we are to have it then let's get it doing the best job possible for us by focusing investment in areas that are not financial sinkholes, but in areas where there is a strong likelihood of increased citizen confidence and an eventual return on investment, or at least stay close to break-even.