The Financial Times is reporting Waiting game begins on US tax rebates.

The first of more than $110bn in tax rebates for US households start arriving on Monday, amid a vigorous debate as to how big an impact this emergency stimulus – and accompanying investment incentives – will have on the US economy.

Some analysts, including Macroeconomic Advisers and Goldman Sachs, believe it could deliver as much as a 2 percentage-point boost to annualised growth in the quarter in which it kicks in.

Others believe that the effect will be much smaller. Bank of America sees a growth boost of a bit under 1 percentage point, Merrill Lynch as little as 0.5 of a percentage point.

Hank Paulson, Treasury secretary, now says that $50bn will be distributed by the end of May, with the first payments sent by electronic transfer this week.

This means the effect may first be seen in May and June retail sales. Some analysts believe the impact will be primarily on second- and third-quarter growth, others on third- and fourth-quarter growth.

The Congressional Budget Office admits that there is “some uncertainty about the rebate’s effect”.

Studies of the 1975 rebate suggest that only about 12-24 per cent of the package was spent in the quarter in which it was received. However, analysis of the 2001 tax rebate suggests that 20-40 per cent was spent in the first quarter it was received, and about two-thirds over two quarters.

In one crucial respect the 2001 and 2008 rebates are fundamentally different. The 2001 rebate was a downpayment on a permanent tax cut; the 2008 rebate is not. This suggests it may have a considerably smaller impact on spending.

Whatever the size of the boost to spending, the effect will be temporary – six months at most – and there will be a negative effect on reported growth when it fades.

Maths mistakes

Many top Wall Street groups are underestimating the short-term impact of the tax rebates on growth by a factor of four, owing to a maths mistake.

To understand why, consider the effect of a $20bn boost to spending on the annualised growth rate of the quarter in which it takes place.

Most analysts did their sums like this: $20bn annualised is about $80bn. That is 0.8 per cent of annual consumption. Since consumption constitutes about 70 per cent of gross domestic product, that equates to slightly less than a 0.6 per cent boost to annualised GDP growth in the quarter.

But the Bureau of Economic Analysis – which compiles the GDP series – says the maths here are wrong.

The correct way to do the sum is as follows: the level of consumption goes up by $20bn or 0.8 per cent in the quarter. But you then have to annualise this increase to get an annualised growth rate, which works out at 3.2 per cent.

Since consumption constitutes about 70 per cent of GDP that equates to about 2.2 per cent extra growth – a four times bigger boost to annualised growth in that quarter than the incorrect approach suggested.

Of course, the actual extra amount spent in the quarter remains the same – $20bn – only the reported growth rates are different.

Rebate Check Is In The Mail

Professor Kevin Depew was talking about the above article in point number one and two of Today’s Five Things. Inquiring minds may wish to take a look. I will add to his thoughts with a suggestion that the money is already spent.

Money Already Spent

Those looking for a big pickup in spending in the third quarter due to stimulus checks need to think again. A Poll shows most Americans will use stimulus check to pay bills.

Nearly 70 percent of taxpayers receiving a rebate plan to use it to pay bills or buy necessities, according to Jason Bloch, a Boston-based district manager in training for H&R; Block, the tax-preparation service.

Breaking down the numbers, 45 percent of the respondents indicated they would use the rebate to pay bills; 21 percent plan to spend it on a necessity, such as groceries or car repairs; 18 percent said they would invest the money; and only 16 percent planned to splurge on luxury items, jewelry, electronics or a vacation.

“The survey feedback clearly indicates that American taxpayers are counting on their rebates and refunds to help make ends meet this year,” said Bloch. “It’s important for Americans to remember that the only way to receive a rebate is to file a tax return this year.”

Interestingly enough, more than 40 percent of the respondents indicated they would prefer the government use the money from the $168 billion economic stimulus program elsewhere, such as reducing the national debt (37 percent), improving health care services (32 percent), shoring up Social Security (17 percent), or improving education (15 percent).

Assuming the numbers are reasonably close, 45% are going to pay down existing debt. Clearly that is money already spent. Another 21% are going to spend it on stuff they were going to buy anyway.

For the sake of argument, let’s assume the remaining 34% are going to spend it all even though 18% said they would “save it”. The question now is how big a blip one would expect to see from that in the third and fourth quarter. The answer is not much.

Some of those willing to spend have already gone out and purchased a new flat panel TV or whatever in anticipation. It’s easy to find 0% interest offers for big ticket items, so the gotta-have-it-now crowd is happily chirping “Why Wait?” That leaves the 18% who claim they will save it. However, let’s assume they will spend it anyway, sometime in the third or fourth quarter.

Before we go too far with this idea, remember that $50 billion will be sent out in May and much of that increase in spending will occur in the second quarter rather than the third or fourth. This means whatever stimulus effect there is will be spread out over three quarters not one.

And none of these economists seem to have factored in the fact that stores are reducing prices by 10% or more trying to win a chunk of those checks. I talked about this idea in No Stimulus From Stimulus Checks.

Certainly it does seem like retailers are planning for a battle on where to spend that check,” said Chris Donnelly, a partner in the retail practice at consulting group Accenture. “We’re going to see a lot of competition from a promotional standpoint among retailers really trying to lay claim to that.

Sears, Kroger, Pizza Hut, Wal-Mart, and even Home Depot are offering deals to win the hearts and minds of consumers. And it won’t just be stimulus check shoppers that pick up those savings.

Let’s piece this story together assuming 34% of this stimulus plan will actually result in future sales. 34% of $110 billion is $37.4 billion. Let’s assume that is spread out equally at say $12.5 billion per quarter. Now that needs to be reduced by lower sales prices offered by all the stores competing for those checks.

And if the 18% who said they would save it really do save it, the increase in spending will only be $5.9 billion per quarter not $12.5 billion, and again that is before factoring in the effect of competition for those sales.

Factor In Jobs

Over the last three months payroll employment has declined by 232,000 (see Unemployment Soars, Jobs Collapse). I am looking for another grim set of numbers for April. In fact, I am looking for a grim set of job numbers for the rest of the year although there could be a surprise somewhere along the line.

Those 232,000 people will all be spending less whether they want to or not. And pretty soon 232,000 is going to be 500,000. And the reduction in spending stemming from that will be month in and month out vs. a one time stimulus from these rebate checks.

Rising unemployment and consumer attitude changes towards debt are going to make mincemeat out of theories that GDP is going to soar in the third quarter.

Addendum

Aaron Krowne at the Bank Implode-O-Meter just pinged me with …

Extending your point that retailers are lowering prices to attract “stimulus check spending” it’s important to remember that price drops don’t just reduce the $6-12 billion additional likely to be spent each quarter, they reduce total sales and hence consumer spending because all prices are affected.

For example a 1% drop in prices, all other things equal, would cause sales to plummet by about $25B for each quarter. That is more than enough to wipe out even generous estimates of the quarterly impact of the stimulus.

-Aaron

Mike “Mish” Shedlock
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