Here’s another clever stimulus idea.  The source is Andrew Healy, who explained it to me over pizza right the day before Christmas.  I’m not sure if he actually advocates it, but here it is:

The federal government temporarily picks up the tab for state sales taxes (or possibly more), as long as the states temporarily stop collecting sales tax.  For example, right now California charges an 8.75% sales tax.  Under the Healy hypothetical, the feds give California a grant equal to 100% (or possibly more) of .0875 times California’s taxable receipts.  The state of California then stops collecting sales tax. 

At first glance, this looks about the same as a temporary federal income tax cut.  But in a world with inflexible prices and wages, intertemporal substitution ramps up the effect of a sales tax cut, but not an income tax cut.  What’s the difference?  When sales taxes are temporarily low, people have an incentive to buy more now.  With inflexible prices, this intertemporal substitution diminishes the surplus in the goods market.  Income tax cuts, in contrast, encourage people to work more now – exacerbating the surplus in the labor market.

In the long-run, of course, Healy’s proposal encourages higher state sales taxes.  Why not have a sales tax of 100% if you know DC is paying?  But as a stimulus package, it has a major advantage over an income tax cut.  Your thoughts?