Roberts on stimulus, again. (updated)

Following on from his commentary on National Public Radio (NPR), Russ Roberts continues to discuss proposals to stimulate the economy. Here Roberts starts by considering a basic question: If you received a windfall, that is, an unexpected increase in your income, what would you do with it? He considers two cases

1. Your rich uncle dies who hated you. But he left you money anyway—$1600. What do you do with the money?

2. The government announces a $1600 rebate for all families, financed by borrowing. What do you do with the money?

The answer, of course is, it depends,

With the inheritance, you feel a little richer. You might splurge on a fancy weekend in New York. Or you might save all of it. Or something in between. But with the rebate, you are less likely to spend it. Why? Because your taxes (or someone's taxes) are going to go up in the future and that will discourage the feeling that you're wealthier.

The basic point here is what economists call Ricardian equivalence, for a given level of government spending, a tax cut today implies a tax increase tomorrow and so you save the tax cut to pay for the future tax increase. If this happens there wouldn't be much stimulus from a tax decrease. As Roberts explains it,

Well, if the government isn't going to cut spending (and they're not, because that would offset the stimulus of the tax cut, wouldn't it?), then it's going to have to borrow all the money to cover its spending for this year. The bonds the government sells are going to have to be repaid. We're going to have higher taxes next year and the year after. I think we better put [the tax cut] aside to pay for those taxes.

Thus no increase in spending.

Update: For a quick overview of the standard view on a stimulus package see this from Arnold Kling, Stimulus: The Mainstream View.