Economic stimulus package : Tax cuts, populism ,or Negative Tax?

There is one political truth that a government may have many macroeconomic goals to monitor, yet will still wish as rapid economic growth to take place as possible.

Recently, the new Thai government declared an economic stimulus package. After its adoption, individuals with taxable income of less than 150,000 Baht will be exempt from income tax, up from the last threshold of 100,000 Baht. In addition, the maximum deductible limit for different kinds of savings has been raised, and individuals whose spouse, children, or parents, are physically impaired can deduct expenses of up to 30,000 Baht per year.

Furthermore, the government has prepared a second economic stimulus package that will soon stimulate the grassroots economy; and will include SMLs, and megaproject investment. Hopefully, the government expects this year’s economic growth rate to be six percent.

This article will analyze the strengths, weaknesses and effectiveness of the government’s economic stimulus measures. I will also propose a very new idea about “negative tax,” which, to my point of view is the most efficient economic stimulus measure.

This article aims to analyze the effect of the stimulus package on Thailand’s macroeconomy in terms of economic growth only, omitting a stability analysis due to the compact nature of this write-up.

First of all, the tax cut policy is good in principle. A tax cut or tax refund will increase the disposable income of the people, which will then become an additional expenditure on goods and services, and, eventually, stimulate the production sector. The classical school of thought even states that tax cuts are the best stimulus to an economy since a tax cut policy will lead to an increase in the economy’s aggregate supply, thus making the economy grow without any trade-off against price stability.

However, policy effectiveness in practice will depend on the target group into which the expenditure is injected. Policy effectiveness is good when the money goes to the poor who have a greater value of average propensity to consume (APC) than those of the richer group. In other words, when they receive money, the poor are inclined to spend almost all of their money, while the rich are inclined to save more.

Unfortunately, since Thailand’s poor have already all had a tax exemption, they will gain no additional benefit from the tax cut measure, but the beneficiaries will be the middle class who paid tax before this measure was announced.

Another category aims to encourage private savings as part of the economic stimulus package, which is a good policy in principle. However, this kind of measure will adversely affect economic stimulation in the short-run because it will make the private sector save more, instead of purchasing goods and services. Some may argue that private savings will be transformed into investment, which can also increase the economy’s GDP. But for now, Thailand’s savings rate is high, so that incremental saving may not stimulate the Thai economy significantly.

To integrate both categories into one picture, the effectiveness of the government’s economic stimulus package may not be as high as expected, because middle-class people who gain tax exemptions are inclined to save, rather than spend on goods and services.

Let’s examine the second approach to economic stimulation; an increase in government expenditure, a populist concept duplicated from the former cabinet of Thaksin, through such projects as SMLs and megaprojects.

Most measures of this kind are injected into the grassroots economy in which people have a high propensity to consume, and encourages them to invest rather than consume. In the mocro level, megaprojects will be followed by a gigantic expenditure on capital goods and in huge employment. Therefore, in principle, it is likely to be effective in stimulating the Thai economy.

Nevertheless, populist projects such as SMLs, will inject money into individuals unequally, and although all villages in Thailand receive it; the distribution will depend on the “criteria” of the power elite in the village. Moreover, bureaucratic procedures have a sluggish effect on expenditure and make it easy to use corruption along the way where the money goes.

Therefore, the effectiveness of the government’s expenditure approach may not be impressive. Though the money goes straight to the grassroots, there are many managerial problems in practice.

In my opinion, as an economic stimulus, negative tax is better than the two previous approaches, since it not only injects money to the poor directly, but also corrects the managerial problems.

The concept of negative tax is supported by many well-known economists, including two nobel laureates, Milton Friedman and Joseph Stiglitz. To adopt this concept, the finance ministry must create the negative tax system, a system in which the government subsidizes taxpayers; besides the positive tax system, which is the current tax system. Since every taxpayer is in both tax systems, for the poor, the tax value will be offset or outweighed by the subsidy. The subsidy will be in the form of tax refunds from the negative tax system, so that the beneficiaries must register in both tax systems by having taxpayer ID.

There are many benefits to negative tax. First, negative tax is effective in stimulating the economy; the money goes straight to the poor; and corruption is weeded out due to fewer procedural steps. Also, since the tax refund covers almost all of the labor force, the negative tax will encourage income equality in Thailand. Finally, negative tax can be considered as an incentive for underground laborers to participate in the tax system, causing a positive spillover into the government’s provision of social security for them.

However, the negative tax has some shortcomings. The negative tax system cannot be initiated very soon. The managerial problem is that the actual income of laborers in the underground economy is not revealed. According to the philanthropic view, the negative tax system does not cover those who are out of the labor force, who can be helped by social security measures.

In conclusion, I think that the current government’s economic stimulus package, both with tax cuts and populist policy, is acceptable, but not excellent. I propose that, in the short-run, the government continue its declared measures to show consistency in government policymaking and, consequently, to earn confidence from both household units and business units, which is necessary for macroeconomy management. Then the government needs to study the feasibility and the implementation of the negative tax system, which is an effective economic stimulus.

Dr Kriengsak Chareonwongsak
Senior Fellow, Harvard Kennedy School , Harvard University
kriengsak@kriengsak.com, kriengsak.com, drdancando.com