California’s $17 Billion Rebate Plan Is Economic Illiteracy

California Governor Gavin Newsom may be surprised to hear this, but his inflation rebate plan is not good economics. In a time when the inflation rate is cresting above 8%, handing out $17 billion to California residents has the potential to make inflation even worse. And it probably will.

The intent of the rebates, which will total as much as $1,050 per resident, is to ease the impact of inflation. The thinking is that prices have risen, so why not hand out cash to help people compensate? A nice idea, except consumers have a high marginal propensity to consume windfalls of cash, especially lower-income consumers, and almost all the money will be spent, increasing aggregate demand and pushing up prices even higher. It’s not hard to see how this could contribute to an inflationary spiral — inflation accelerates, the government hands out more cash, which pushes up prices even more, which encourages the government to hand out even more cash, and so on. This is how cost of living increases in wages and benefits helped keep inflation high in the 1970s.

There is a lot of evidence that a significant cause of the inflation we were experiencing was not the years of ultra-loose monetary policy by the Federal Reserve, but rather profligate government spending during the pandemic, with things like the Paycheck Protection Program, stimulus checks and child-care tax credits plowing $3 trillion into the economy. That $3 trillion is still sloshing around, pressuring prices higher. You might recall the fuss that was made about the Fed’s quantitative easing between 2009 and 2014, and how it was going to spark inflation, but it never happened. 

Sure, the California rebate is smaller than the federal pandemic stimulus by a factor of more than 100, but it doesn’t mean it won’t have an impact on the national economy given the massive size of the state’s gross domestic product. If it was a standalone country, California would control the world’s fifth-largest economy. And it’s not like California is the only state considering some sort of monetary relief. States including Colorado, Maine, Indiana and Delaware are implementing similar measures to help people cope with high prices, according to Bloomberg News. 

California has the capacity to hand out money thanks to a massive $98 billion budget surplus accumulated through a combination of high taxes and an economy that produces quite a bit in the way of capital gains when the stock market is riding high, like it did the last two years. But as we have seen in the past, tax revenue can quickly dry up causing all sorts of troubles, like what happened after the dot-com bubble burst two decades ago. 

When you examine the stimulus checks issued by the federal government during the pandemic, a good chunk of the - 31% - was used to pay down debt and only 42% was spent. But that may not be representative of what may happen with the California rebates, because there simply wasn’t much to spend money on during the pandemic. It’s probably that a much higher percentage, perhaps as much as 70% to 80%, of the California rebate checks will be spent.

Stimulus checks are an inequitable way to distribute a surplus. The wealthy and corporations likely paid the majority of taxes, and now those taxes are being returned to people who paid a much smaller share. The cynical might say this is a form of populist vote-buying, and they’d be right. The better thing to do is to institute a permanent reduction in tax rates across the board, even for high incomes. One-time rebates or stimulus checks will be spent, but permanent tax reductions will be saved, without the inflationary impact. Given California’s large surplus, income taxes could be reduced to say, 9%, without any reduction in government services. Reducing tax rates would make the business climate more hospitable, as California is suffering an exodus of high-income taxpayers and corporations.

Another option available to Newsom is to pay down debt. California has $143 billion in municipal bonds outstanding, and the credit-rating firms would probably be happy to see the state reduce its leverage a bit on the idea that it makes sense to save money and reduce borrowings in good times to better weather the bad times. And 2022 tax revenues will undoubtedly be lower than 2021, owing to the bear market in stocks.

Newsom’s rebates represent economic illiteracy of the highest order. You don’t fight inflation by giving people more money to spend. But of course, the intent is not to fight inflation. The intent is to redistribute, and curry favor with voters. California represents about 20% of the U.S. economy, so the impact is large, and will be felt across the country. The last thing we need is more inflation, but we are going to get it.More From Other Writers at Bloomberg Opinion:

• What Biden Should (and Shouldn’t) Do About Inflation: Editorial

• California Versus Florida, a Covid Reckoning: Justin Fox

• Newsom Shouldn’t Mimic Texas’ Disrespect for Law: Noah Feldman

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Jared Dillian is the editor and publisher of the Daily Dirtnap. An investment strategist at Mauldin Economics, he is author of “All the Evil of This World.” He may have a stake in the areas he writes about.

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