Since the World Health Organization first declared the COVID-19 outbreak a global pandemic on March 11, the virus has spread quickly through the U.S. According to the CDC, there have now been over one million confirmed cases in the United States and over 60,000 deaths, with both numbers increasing every day. To slow the spread of the virus, virtually every institution has responded in unprecedented ways. Schools and universities have moved to online learning. Corporations have asked employees to work from home. And federal, state, and local governments have developed guidelines and mandates that have shuttered businesses across the country.
As businesses shut down and customers stay home, the economy has taken a nosedive. More directly than 30 million Americans applied for unemployment from mid-March to the end of April. In response to record-setting unemployment claims, federal and state governments have crafted rapid policy responses to help workers who find themselves out of a job. On March 27, Congress passed the CARES Act, which includes $300 billion in direct cash payments to eligible Americans, along with support for businesses and state and local governments.
What makes the CARES Act unique is that it will send direct cash payments to Americans to keep people afloat. Single Americans earning less than $75,000 and married couples earning less than $150,000 can expect a payment of $1,200 per person, with additional payments of $500 per child.
Though this is not the first experiment with direct cash payments in the United States, it is the largest to date, and may not be the last during the pandemic. For example, legislation has been introduced by Representatives Tim Ryan and Ro Khanna that would send $2,000 a month to every eligible American over the age of 16 for at least six months.
Policymakers usually respond to an oncoming recession with stimulus packages. But the current economic downturn spurred by COVID-19 is unique. In the past, these packages involved tax cuts and rebates meant to encourage people to spend more money in restaurants and shops. Past stimulus efforts aimed to keep people working and the economy humming. But today’s downturn is in many ways more similar to a natural disaster than an economic crisis, and thus calls for an entirely different kind of approach.
Instead of stimulating the economy, the current policy aims to put the economy into hibernation mode until it’s safe to reopen businesses and bring everyone back to work. In addition to the expansion of unemployment insurance, direct cash payments are being tried as a way to keep everyone afloat over the next few months and to help them afford basic living expenses like rent and groceries. The current crisis is indeed unprecedented in modern history, but we can still learn key lessons from past experiments with direct cash transfers during an economic downturn. And although $1,200 may not be enough to sustain people through a situation that is likely to stretch on for months, existing research suggests that it can certainly help.
Direct cash payments in 2008
In February of 2008, facing a worsening financial crisis, Congress passed the Economic Stimulus Act of 2008, which sent $120 billion to 130 million U.S. tax filers. Single individuals making less than $75,000 received payments of $600, with couples making less than $150,000 receiving $1,200. Households received an additional $300 per qualifying child. President Bush called the policy a “booster shot” that would push Americans to spend money and bolster the faltering economy.
How did Americans spend their stimulus money? The University of Michigan’s Survey of Consumers is used to determine consumer expectations about the economy as a whole. As stimulus payments were sent across the nation in 2008, an additional question set asked households if they planned to use most of their tax rebate on additional savings, additional spending, or to pay down debt. About 28 percent of those receiving a stimulus check planned to spend most of their rebate while 50 percent chose to mostly pay off debt, and 23 percent chose to set most of it aside as savings.
Christian Broda, Managing Director at Duquesne Capital Management, and MIT Finance Professor Jonathan Parker also studied the 2008 stimulus and found that “the average household’s spending rose by ten percent the week it received a Payment and remained high cumulating to 1.5–3.8 percent of spending over three months,” and that these estimates imply nationwide increases in “demand of 1.3 percent of consumption in the second quarter of 2008 and 0.6 percent in the third.”
Broda and Parker also found a large overall increase in spending due to the 2008 payments. Most significantly, “While spending at grocery stores was barely affected by the rebate, consumption at supercenters and other non-grocery outlets increased significantly.” In a survey, the authors found spending increases in every tested category.
While some used their payment to make simple purchases such as food and clothing, there were significant spending increases on durable goods such as appliances and furniture alongside increased purchases on entertainment. The authors found increases in personal consumption expenditures (PCE) and further add that “these calculations do not include any potential multiplier effects, which might make the full impact of the rebates on the economy even larger, nor do they include price effects, which might mitigate their impact on real GDP.”
Finally, Broda and Parker also found that the speed of the Treasury in distributing payments is crucial as “a household’s spending did not increase significantly when it learned about its payment.” Rather, spending increased once the payment was actually received. That creates even more urgency around current efforts to get payments to Americans quickly. According to the House Ways and Means Committee, it could take up to five months to get stimulus checks out to everyone who is eligible in 2020. For those who are currently out of a job, that may be too late to help with things like rent payments that are due now.
Direct cash payments vs. payroll tax cuts
The 2008 experiment also sheds light on the efficacy of payroll tax cuts compared to direct cash payments. The stimulus payments made to Americans in 2008 were followed up by the American Recovery and Reinvestment Act of 2009, which included $232 billion in tax cuts for individuals. Over half of those cuts were part of the “Making Work Pay” Tax Credit which reduced tax liability for Americans making less than $95,000 a year for an individual or $190,000 for couples. The credit showed up in the form of reduced withholdings on paychecks and added up to a maximum reduction of $400 for individuals or $800 for couples.
A paper by economists Claudia Sahm, Matthew Shapiro and Joel Slemrod published in 2012 compared the effect of the direct cash payments made in 2008 to payroll tax cuts made in 2009. The researchers found that the 2009 tax cuts boosted spending by 13 percent, but those one-time payments had almost double that effect — boosting household spending by 25 percent.
While tax cuts may work in other forms of economic crises, the economic reactions to the COVID-19 pandemic have left Americans across the nation in need of immediate assistance. In this sense, payroll tax cuts would be less effective than direct cash payments as months may pass before working Americans receive the full stimulus. While a payroll tax cut would make each paycheck a little larger as less income would be withheld each month by employers, a direct cash payment offers the stimulus in a single payment that can be used for whatever recipients need most.
Other forms of tax cuts, on the other hand, can take until the end of the tax year to show up in a household’s budget. These tax credits are available as a refund when a household files their taxes, for example. Further, neither a payroll tax cut or other types of tax credits would help those who are currently unemployed since they aren’t receiving income or paying taxes in the first place. CNBC reported in January that only 41 percent of Americans had enough savings to cover a $1,000 emergency, and this was before massive unemployment claims. Those receiving a direct cash payment need to notice a large lump sum payment coming to their aid.
Research also suggests that direct cash payments can help people reduce high-interest debt and improve their financial situation during a downturn. University of Chicago Economist Marianne Bertrand and UC Berkeley Finance Professor Adair Morse found that “using the natural experiment of the 2008 tax rebate, we find a persistent decline in payday borrowing in the pay cycles that follow the receipt of the tax rebate.” Bertrand and Morse also found that “The reduction in borrowing is a significant fraction of the mean outstanding loan (12 percent).” This indicates that Americans in a credit crisis were able to rely on the direct cash payment from the stimulus rather than turning to high-interest payday loans.
Overall, research indicates that direct cash payments helped Americans weather the financial storm that was well underway in 2008. As a result of receiving their payment, households increased their spending on necessities as well as things like entertainment, reduced their financial strain by paying down debt, and reduced their use of high-interest loans. All of this suggests that direct cash payments appear to be an appropriate and effective policy response to the COVID-19 induced economic downturn.
Why 2020 is different, but also the same
Perhaps the most recognizable factor of the recession of 2007–2009 was the incredibly high unemployment. As reported by the Bureau of Labor Statistics, “In December 2007, the national unemployment rate was 5.0 percent, and it had been at or below that rate for the previous 30 months. At the end of the recession, in June 2009, it was 9.5 percent. In the months after the recession, the unemployment rate peaked at 10.0 percent (in October 2009).” The goal of the fiscal stimulus package in 2008 was to get Americans to return to restaurants, supermarkets, and other places of business to help spur job creation. Overall, economic indicators show an increase in national spending following the cash payments suggesting the policy met its goal in terms of direction if not magnitude.
Amid the COVID-19 pandemic, we face much higher unemployment and an entirely different economic situation. World leaders continue to encourage social distancing and, in many cases, require non-essential businesses to close completely. University of Michigan economists Betsey Stevenson and Justin Wolfers explain how the current crisis is different than those we’ve experienced in the past:
In a typical recession, the goal of fiscal stimulus is to get consumers back into restaurants and stores. But that wouldn’t be appropriate today when the government has closed millions of stores to help prevent the transmission of the coronavirus.
Instead, the government needs to make sure the hardest-hit families have enough income to keep food on their tables. The goal now is not the typical get-spending-going stimulus of past recessions, but rather social insurance — that is, cash payments — to buffer family budgets when many people lose their jobs or are required to work fewer hours. Both households and businesses need to keep paying their bills, even in the face of a sharp, temporary fall in income. A cash crunch could lead to a wave of ruined credit scores, home foreclosures, and bankruptcies. Solving this liquidity problem now is essential if business as usual is to resume when the virus recedes.
As Wolfers and Stevenson point out, the two crises are different in fundamental ways. While direct cash payments in 2008 were intended to spur consumer spending, the goal of the current policy is to keep people (and businesses) afloat until we can safely restart the economy. Given that goal, direct cash payments seem likely to be our most effective option. Research suggests that if made quickly, direct payments are the most efficient way to help people meet their basic needs in the short run.
In the longer run, maintaining relationships between employers and workers will be key to ensuring a speedy recovery. In addition to payments to keep workers and businesses afloat, the CARES Act also established funding for small business loans, some of which can be forgiven if employers agree to retain employees throughout the COVID-19-spurred shutdown. To be sure, there will be many hurdles ahead as we work to find the most effective way to help individuals and businesses weather this storm. But research suggests that this support will help ensure that more workers can keep their jobs, making it easier for everyone to get back on their feet in the (hopefully) very near future.
CGO student research fellows Zachary Archibald, Keanu Hansen, and Cailean Bushnell contributed to this article.