Wider is safer

Basic Premises:

The only way to ease any debt crisis is to raise after-tax income in relation to debt payments. 

Congress should act now to raise after-tax income, or at least keep it from falling faster.

The quickest way to do this would be to cut taxes now.

A broad-based tax cut can be in workers paychecks within a month, before millions more lose those paychecks.

Widening the size of the brackets would make a lot of sense, since there is a great gap between marginal tax rates (up to 35%) and effective tax rates (about 12% of AGI, adjusted gross income).

Cutting the corporate tax rate would help maintain investment and employer solvency during the credit panic, while regaining competetiveness with our trading partners.

The situation: 

Personal spending, income, employment are falling while debt defaults and foreclosures are increasing. Since one man's income is another's expense, income is falling as well. Last quarter's report on GDP showed a rise in the nominal GDP of only about 1% rate per year. After inflation, that represents contraction. As businesses and households try to repay their debts on falling revenues, the situation only gets more difficult. Since the crunch is/was world wide, other people, businesses and governments are trying to do the same tightening of their belts.

While governments around the world have tried to shore up their banking systems, to maintain the capacity to lend and create money, the source of the problem-- doubt about mortgage repayments here in the US-- remains unresolved. A nasty recession could throw many more mortgages that are current and being repaid on time into the late or default category. This would spread the panic again. Households cannot all sell assets at the same time, creating a further glut of unsold homes and cars and stocks and furnishings, and raise the money to pay their debts.

Since the US government has the capacity to borrow cheaply, while most businesses and individuals are facing rising difficulty or higher costs, the government can lower taxes to raise incomes back to where they were, or close, in the aggregate. This would provide all parties more time and money to work out their situations in a less forbidding context. Lower taxes would raise after tax cash flows, making up for some of the missing income that people were expecting.

A rebate would provide a one time increase in income, leading people to fell a bit better off, yet it would not provide much of a lasting effect unless it was very large. Most studies show that only 20-25% is spent in the quarter it is received. To replace a loss of $9 trillion is stock market wealth alone would be an almost impossible task. Even to replace a 3% decline in income-- about $300 billion-- would require a rebate of much more than that $300 billion, since recipients would likely see it as a windfall, not to be squandered. A rebate was tried in the beginning of 200, yet here we are still in recession.

Since the 1970's, fear of inflation has constrained the amount of any fiscal stimulus due to the ongoing inflation that we were experiencing. This is less true now that in decades. Inflation is low and falling and so is future inflation!

The recommendation:

A large and continuing tax cut would lead to a stabilizing trend in consumption, as people spent the addition to income and spent some of the future tax cut by borrowing more or adding less to savings.

A simple way to reduce the dead weight loss of the income tax would be to widen the tax brackets, so that fewer people face rates above the basic 10%,  the rate that collects most of the revenue. In fact, that-- rate 10%-- collects more than half of the present income tax revenue on a marginal basis. Congress could more than double the width of the income tax brackets and still increase borrowing by about half of the "stimulus package" Paul Krugman recommends.

Since rising incomes over time push people into higher brackets, this would undue some of that effect. It would lower the "tax wedge" between payer and receiver, allowing market incentives more effect. Wider brackets would make it easier to estimate ones liability for planning purposes. Those high rates that make tax avoidance so profitable would be reserved for fewer taxpayers, yet leave the top rate on the unpopular rich unchanged. While not the best cut from a supply-side perspective, it still should have a price effect on the general supply side of the economy.