A sales tax exemption could jump start consumer spending

Some economists are calling the U.S. economic slump the worst contraction since the post-World War II demobilization recession that began in 1945; certainly, it's the the worst slump since the 1981-82 Reagan recession.

What are its defining characteristics? Of course, the end of the housing bubble, and a deep slump in home prices and sales; a large increase in layoffs, stemming from that sector's correction and its ripple-effect on supporting sectors; and a decrease in consumer spending.

Of all the recessionary trends, the one that may be the most damaging -- and enduring -- concerns the pullback in spending. And it's the dearth in spending throughout the economy, involving business-to-business, not just retail, that's troubling economists.

Two examples: a local nursery and landscape business decides not to hire contractors to expand the business's main greenhouse, because the extra room for plants housed there won't be sold. Another: a local Italian food restaurant does not replace his two serviceable -- but very old -- primary ovens with more efficient ovens because a 30% reduction in meal revenue makes it impossible to pay for the new ovens.

While economists agree that after a decade of overconsumption the U.S., as a society, must increase its savings rate in the decade ahead (it has, in 2008, to about 3% from about 1% for 2005-2007), what it should not do is dramatically increase its savings rate during a recession, says economist Peter Dawson. However, due to that decade of overconsumption that started in 2001 that led to a negative savings rate, that's exactly what consumers are doing now, Dawson says, "and if that continues that will really complicate the recovery timetable."

It's important to save, but . . .

Historically, consumers build up savings during booms, then draw down on them during recessions. The U.S.'s current tendency reverses that historical pattern and does exactly what economist John Maynard Keynes said a nation should not do,. A Keynesian adage is, "Savings is a good thing, but if everyone saved everything all the time it would be a disaster." Essentially, that's what the United States is doing right now: everyone is saving, "either on concern about a deepening recession, or to make up for the previous period of overconsumption," Dawson says.

Further, if the trend continues, the pull-back will have serious consequences for the U.S. economy. If both b-to-b and consumer spending remain negative, that will reduce U.S. GDP by 1.0-1.7 percentage points, all but guaranteeing a continuation of the recession.

The U.S. spending totals have also been hurt by the departure of millions of undocumented workers, who have left the U.S. due to lack of jobs and returned to home countries, such as Mexico, taking their retail spending dollars with them. Dawson estimates that as many as seven million undocumented workers may have left the U.S. since early 2007.

Hence, the U.S. is caught in a dilemma, one of many dilemmas in this recession: how can it increase consumer spending to generate demand to jump-start the economy, at a time when it should also increase its savings rate to make up for the excess consumption of 2001-2007?

It's at times like these that economists get creative, and Dawson says one way the U.S. can address the problem is by temporarily implementing a sales tax exemption. For now, Dawson says the U.S. should concentrate on getting more b-to-b activity and enticing a few more consumers to make big ticket purchase: that should leave a portion of the population still saving at a healthy rate.

Here's how the sales tax exemption would work. A citizen buys an item, say a new refrigerator for $2,000 with an 8% state and local sales tax, and the store discounts the sales tax at the register, $160, then fills out a federal form for U.S. Treasury reimbursement at the end of the quarter; or the purchaser fills out the same at the store. The federal government reimburses the state and local governments for the lost revenue.

"There is no loss in state and local revenue, but the result is an 8% savings for the consumer, which should prompt some additional consumer sales as well as b-to-b purchases," Dawson says. "It's another another way Congress can provide fiscal stimulus to the ailing economy."

"The largest impact would occur with big-ticket items, like appliances and cars," Dawson says. "Take a 15% dealer discount on a new $40,000 car and add another 8% discount and you will get some fence-sitters into the showroom. That's another $3,000 [actually $3,200] in savings. It would encourage sales, which is one of the many things the economy needs right now."

Economic Analysis: An even more creative and radical approach would be an 'augmented sales tax,' whereby the federal government reimburses state and local sales taxes, and pays a 25% bonus to the consumer. So in the above example the $40,000 car purchaser would get a $6,000 dealer reduction, a $3,200 sales tax exemption, then a $800 federal government rebate, for $10,000 in savings or a $30,000 final cost for the new car.

To be sure, a sales tax exemption is a creative and radical approach to generate demand. But it's one policy makers should consider to end and reverse the negative cycle that's at the heart of the pronounced recession.
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