Senior Fellow Kevin A. Hassett

The package, still being ironed out by the two parties, will probably include a large temporary tax rebate for individuals and a round of temporary business tax cuts.

This movement toward a short-run stimulus package is regrettable. Here's why.

Suppose you had to choose between two economies. The first is entering a recession and has an economically efficient tax code. The second is going into a recession and has a tax code that's a crime against economics. Which economy would you prefer? You'd rather be in the second circumstance.

A broken tax code is an asset in bad times, because there are so many things to fix. Any number of reforms could help turn the economy around. By focusing only on temporary measures, the administration and Congress are overlooking our greatest asset, our lousy tax code.

What would a temporary tax plan do for the economy?

There is a long debate about the effectiveness of temporary tax cuts, going all the way back to Milton Friedman. Friedman argued that a rational person who is given an extra dollar today will not consume much of it, but rather recognize that his "permanent income" has gone up by about the interest on a dollar. So his consumption would go up by five cents, not a dollar.

Helping the Poor

Subsequent literature argued that poor people who eat hand to mouth might well consume an extra dollar from a temporary tax cut, and the evidence seems to support that view. So a helicopter drop of cash on poor individuals, the key measure planned, may well add some demand-side stimulus this year.

There is some evidence that consumption increased in response to a similar measure in the last recession. A 2004 paper by economists David S. Johnson, formerly of the Bureau of Labor Statistics, Jonathan A. Parker, then of Princeton University, and Nicholas S. Souleles of the University of Pennsylvania found that, in response to the 2001 tax rebates, households spent 20 percent to 40 percent of their new income in the first three months after receipt, and another third of the rebate during the next three-month period.

On the business side, the most likely measure will be a replay of the temporary partial expensing enacted first in 2001, probably with a rate of 50 percent.

Under current law, when a firm purchases a machine, it's not allowed to deduct the cost of that machine from its taxes, but rather must spread that cost out by deducting a little bit annually for many years.

50 Percent Cut

Under the proposal the president is likely to favor, firms would be allowed to deduct 50 percent of the cost of that equipment this year, and then expense the rest on normal depreciation schedules.

Such a measure lowers corporate taxes for firms that purchase machines, and is economically equivalent to an investment-tax credit, a measure that has been adopted in just about every recession since 1960.

My own back-of-the-envelope calculation suggests that the percentage reduction in the cost of capital for firms would be about 5 percentage points. Much economic literature suggests that firms would generally increase their capital spending by as much as 5 percentage points in response to that.

Thus, there would indeed be an economic stimulus, although it would likely not be that large.

Good for Equities

The investment response to partial expensing isn't its only positive point.

Economist Drew Lyon of PriceWaterhouseCoopers has studied the response of the stock market to investment stimulus measures like partial expensing. He found strong statistical evidence that share prices of firms that purchase lots of equipment tend to significantly outperform the market.

While the market might have already responded to this, it is likely that an investment strategy that profits from the outperformance of capital-intensive firms would reap healthy profits during the next few months.

As Fed Chairman Ben Bernanke emphasized last week, it isn't clear that the economy is in recession yet. Indeed, the data for November were strong enough that a recession would have to have begun in December at the earliest. Accordingly, a stimulus plan now would, even an opponent must concede, arrive in time to help us avoid a recession.

Significant Cost

Thus, the stimulus package being considered would provide some economic insurance against a recession and probably at about the right time. But it would do so at a significant cost.

After all, Congress is about to focus its attention on the economics of stimulus plans, and dedicate $150 billion to an attempt to provide an adrenaline shot to the economy. The end result will be that we have a slightly smaller chance of having a recession.

The cost will be that the chance of any other tax bill passing this year will go to zero as Congress moves on to other things. We are about to waste another year that could be better spent fixing a tax code that is utterly broken.

Kevin A. Hassett is a senior fellow and director of economic policy studies at AEI.