Consumers are aware that “cash for clunkers” is over, that the $8,000 first home tax credit expires in a few days, that many foreclosure moratoriums are expiring and that the latest federal mortgage adjustment program is off to a very slow start due to the usual bureaucratic delays as well as the inability of most homeowners with delinquent mortgages to carry the mortgage with the small adjustments permitted.

The long and deep recession has exhausted the resources of many households and the promised federal help is too little and too late for them to continue near normal household spending. The assessment of current economic conditions in the October survey plunged to the lowest level in the long recession. The difficulty of finding jobs worsened but more importantly the assessment of personal financial conditions and prospects dropped.

This result is not surprising. The President and Congress choose an ineffective format for the stimulus program, rejecting stimulus designs that had worked before.  First, about 2/3’s of the funds were scheduled for spending so far in the future that they have not and will not have a significant stimulus impact while consumer confidence is stuck at a deep recession level and the unemployment rate is rising rapidly. This was done to enact a large expansion of the federal government disguised as a stimulus program.

Second, the concern about getting the stimulus money to the “right” people resulted in an extreme bias in distributing funds to the lower end of the income scale. There may be economic equity reasons to do this but is not an effective stimulus design. Much of the money was used to retain public employees, many of whom will now be laid off in the coming months as budget reserves continue plunging. Another large share of the money was used to subsidize low and moderate income families who were cutting or at risk of cutting their normal spending, including for housing.

This permitted several million households to continue near normal spending, including for housing, for up to 4-5 months. Now that the stimulus subsidies are either peaking or expiring, these households again face large spending cutbacks and in many cases foreclosures. What did we get from this? We got a few months of relief for financially troubled households and a temporary boost to the economy that was neither big enough nor fast enough to jump starts a sustained economic expansion at a progressively expanding growth rate.

Congress will soon be considering what to do about setback in confidence and the resulting slower pace of recovery.  We may be threatened with another dip in the recession unless a third stimulus plan is enacted. If stimulus III takes the same form as Stimulus II, the result will be the same. The economy will get a brief boost which will fade before the end of winter.

Experience is clear that the most effective stimulus plan is one that changes the incentives for future spending rather than covering bad debts for past excessive spending. This means lowering income tax rates.  And this is more effective if the cuts are across the board so that high income households get a large enough tax reduction to induce them to spend more on durable goods and expensive services where the spending multiplier is larger. Presidents Kennedy, Reagan and both Presidents Bush knew this but President Obama and his congressional allies can not bear to see money go initially to the “wrong” people.

If you think these thoughts are uncaring you need to separate your preferences for income distribution from the imperative to immediately spur higher sustained economic growth. Different forms of spending are better for one than the other. Confidence and economic growth will remain sluggish until the incentives for future spending are improved. Households struggling to save their home and maintain basic household spending do not need an incentive to spend.

Instead, higher income households need an incentive to spend.  Instead, they are constantly being demonized and threatened with higher taxes, higher healthcare costs and higher electric bills. These are the people who have the savings and credit to spend more.  But most of what happened in Washington this year has lowered their confidence because of concerns about the security of their discretionary income. Added spending by this group will produce the self-sustaining jobs that will provide income to those who spending is now severely constrained.  This happens when they get jobs producing items that people voluntarily buy.

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