Personal Finance meets Stimulous Plan

In the face of growing fears of recession or stagflation (recession with inflation) President Bush, Mr. Bernanke the Federal Reserve Chairman, and most of the presidential candidates called for tax cuts, and naturally the House immediately pushed a bill to that effect.

The reasoning is the Keynesian economic view, as discussed by the Wall Street Journal’s editor in the January 18 edition, that prescribes that the government give money to low and moderate income people who will spend it, thereby creating demand for goods and services, and “stimulating” the economy. Mr. Bernanke emphasizes the “low to moderate” because higher income people would not spend the money but save it.

Four main questions should be asked: Are the tax cuts going to stave off recession or stagflation and help in the short term? Are tax cuts good for the long term? Are tax cuts the “right” thing to do? Where will the money come from?

I provide my clients with advice on how to create and grow wealth, and simply put, it is not by “spending your income away.” In fact, when I show my clients how to reduce their expenses by optimizing their assets and reallocating their expenses, often paying lower taxes as a result (I guess I should be given rebates by the government for my work?), I do not tell them “oh, please go ahead and spend it.” I tell them the money is going to savings and investments. The simple reason is that this money is to fund their retirement. I say so regardless of what level of income and wealth the client is.

The President, Congress, the Fed’s chairman, and the presidential candidates are telling everyone exactly the opposite. They are telling us, “spend money, don’t save it.” This is in the face of several known problems with the US economy and its future.

Firstly, the savings rate in the past decade has been dismal and even reached negative levels. Most Americans do not have enough saved for retirement and are not likely to have enough to maintain a moderate life style, let alone their one at retirement. This is when they are budgeting for 10-15 years of retirement under the “average age” assumption, when they should be budgeting for 25-30 years, assuming a retirement age of 65-67.

Even worse, Social Security is bankrupt in the sense that all projections are showing it will not have enough money at some point in Baby Boomer’s retirement future.

Therefore, spending those tax cuts is the wrong thing to do for exactly the people who are supposed to get it, the low to moderate income ones.

Of course, if the people who are to benefit from the proposed tax cuts would save the money, as they should, instead of spending it, it would defeat the purpose. The economy would not receive the money, and would not be “simulated.”

Thus, the tax cuts are not “the right” thing to do because they encourage spending when the problem is that people should be saving more.

Where would the money come from?

The answer is simple. Given that the government runs a deficit, it has to come from future income, either in the form of lower healthcare, education, social security, or other governmental expenditure on future benefits, because it definitely will not come from special interests expenses during an election year.

The silly argument proposed is that the tax cuts will stimulate the economy, thereby produce more taxable income, and therefore tax revenues, thus paying for themselves. Unfortunately, this sounds like a bad joke I sometimes tell that starts with two people walking down the street and seeing a pile of horse excrement (change the word accordingly), ending with the pile gone and the two being happy for having had a high monetary trade volume.

Then if this is clear, and given that there are 76 million baby boomers who tend to vote in higher percentages, are the presidential candidates willing to tell them: “look, I need to make you feel good now so you elect me, so I offer this tax cut, and the result will be that you’d face even harder times at retirement.”

Will the tax cuts solve the short-term issues of recession or stagflation?

Firstly, more money means higher inflation, and therefore a higher chance of stagflation. Secondly, the looming recession, which has multiple factors, is definitely not a result of low consumer demand. Therefore, increasing consumer demand, temporarily, is like covering an inflamed wound with a bandage without applying antibiotics to cure the underlying infection. The only thing it does is make the inflammation even worse.

Fundamentally, tax cuts do not solve the long-term problems the US economy has. It doesn’t solve the trade deficit, which means basically the US is buying more than it is selling, which in personal finance terms means the country’s income is less than what it spends. It also doesn’t help the budget deficit, which means in personal finance terms that the country is borrowing on its credit card, leaving the bill to future generations to pay. In fact, the tax cuts are only going to make it even worse. If in providing my clients with financial advice, I would tell them to borrow more on their credit cards so they can spend more today on things they can’t afford to begin with, my clients would walk out of the door without a second thought. However, for some strange reason, we buy it when President Bush, Mr. Bernanke, Congress, and the presidential candidates provide us with such advice.

Borrow on your credit cards, everyone. “The government” (you and your kids) is paying the bill.