The following graph from the Congressional Budget Office shows the projected output gap between actual and potential GDP with and without stimulus spending, i.e., the American Recovery and Reinvestment Act (see full CBO presentation). The CBO presentation highlights the implementation lags of fiscal policy, and illustrates why a stimulus package that stretches over 2 or 3 years seemed justified given that the CBO expected the GDP output gap to persist for longer than one year. Projections have only 24% of the money being disbursed in fiscal year 2009, 74% disbursed by the end of FY 2010, and 91% disbursed by the end of FY 2011.

Source: Congressional Budget Office

Given the back-loading of spending, and the realization that the recovery is not taking hold as quickly as most would want (except possibly by politicians up for re-election next year and looking for an election year boost), this is creating a problem now for both the administration and Congress. On the one hand, quicker, and more front-loaded stimulus seems warranted, yet data such as that provided by the CBO has been used to justify the huge delayed spending in coming years. Therefore, if the projections are correct, then patience is in order, but something tells me that is not going to fly as unemployment nears 10 percent.

So how do you speed things up? As outlined by the CBO, you could waive environmental reviews, award contracts without competitive bidding, or simply not dole out money by jurisdictions, but instead give money to those who can most efficiently spend it (shovel-ready project). The first one is a non-starter given the environmental shift of the current administration, the second is going to be difficult given the criticism that no-bid projects received in the last administration, and the last one is simply unacceptable to anyone in Congress - given their parochialism and the fact that it actually makes some sense (and of course, you need shovel-ready projects on a rather large scale - most are probably already funded).

So on the short-term, what needs to be done? The quickest way is through changes to taxes. This could come in rebates (which are relatively quick in non-tax months, but also somewhat ineffective when people are scared and the savings rate is increasing), or through lowering withholding (currently tried with the middle class, but not having the desired effect). This leaves suspending some income taxes for a period of time, or lowering income taxes on everyone, including the wealthy and corporations. Suspension is difficult to sell given the state, or perceived state, of social security and medicare needs, not to mention the growing deficit (even though lower rates can bring in higher receipts), while reducing taxes on corporations and the wealthy is anathema to most of those currently in power.

The limited real and political choices available has now caused the discussion to come full circle - backed to considering another stimulus. I forget - what was that definition about doing the same thing again and expecting different results? If President Obama is not able to convince the American public and Congress to be patient, we may find out the answer rather quickly.

As the Obama Administration considers ways to pay for their proposed universal health care system, and everything else for the matter, old habits like cigarettes, and growing ones like soda consumption, are being considered for new and/or higher taxes. While it seems like everything is currently on the table, the administration may only need to look up for inspiration, and another source of revenue. Greg Mankiw and Matthew Weinzieri, both from Harvard, have proposed taxing people based on their height (see the Fox Business News article). Crazy and arbitrary? Maybe not.

To backup their proposal, Mankiw and Weinzieri cite studies that show a correlation between height and income. As it turns out, previous research found that each inch of height added about 2 percent to a man's income on average (sorry ladies, only men were considered in the study). Statistical data snooping? Once again, maybe not. According to the theory, it is believed that exhibiting height early in life allows adolescences to develop characteristics such as self-esteem that are later rewarded in the labor market. Others, conducting similar studies, hypothesize that proper pre-natal and childhood nutrition also helps to explain the correlation between growth (height) and cognitive ability (also helpful in the labor market).

Carrying things forward, since tall people are more desired by the labor market, they of course will earn more money, and subsequently pay higher taxes. So who cares you might say. Even if tall people do make more money, they are already paying more taxes. How do you generate more revenue? Simple. Tax those who are tall, regardless of their current income level. After all, as the researchers mention, if the goal is to “maximize the level of happiness through a redistribution of income,” then why not tax those people who are not only already happy (i.e., rich), but also those that are most likely to eventually be happy down the road.

While some may be thinking that this is just another academic study, and therefore a waste of time, it does offer some important points, even if we never tax people based simply on height (at least I hope not, given that I am over 6 feet tall myself). Weinzieri asked the question: "Does government have the right to ask those who have the ability to earn more to pay more?” When taxes on cigarettes and soda are consider to pay for health care, are we not in many cases penalizing healthy individuals because we think that they have a higher chance of getting sick down the road? Could we do the same for tall people, in the name of spreading the wealth and happiness? Carried further, why should someone buying a new car pay more personal property tax than someone with an older car, when the new one is probably more fuel efficient and better on the environment (and the health of everyone)? Are we taxing the correct source, or promoting the behavior we desire?

In conducting and publishing their latest research, Mankiw and Weinzieri have not simply pointed out a statistical correlation, or helped to justify a new tax system. Instead, they have done something far greater and more useful. They have introduced new questions for everyone impacted by the existing tax code, or those looking for new ways to justify taxing one group over another. In short, they have created a dialog. Socrates would be proud ......... as would a few flat tax proponents.

As the country and the financial markets struggle to both understand and swallow the need for a $700 billion bailout of the financial system, the impact of using taxpayer money to fund such a bailout could have repercussions beyond the credit markets. The money will have to come from somewhere, i.e., taxes and/or deficit spending. As such, the potential flooding of the economy with money, and a further possible lowering of interest rates, could create increases in inflation. While this will affect nearly all areas of the economy, it could once again provide a catalyst for raising energy and commodity prices. In fact, just recently Barclays predicted that commodities will in fact revive their sharp and historic correction over the summer, and are simply in a normal correction stage rather than a change in demand (see Bloomberg article). If it is true that demand will stay strong, or at least will not collapse due to a global slowdown, any increase in deficit spending, lowering of interest rates, and further devaluation of the dollar could certainly be bullish for commodity prices. But of course, this depends on the strength of the global economy, which will depend to some degree on the handling of the credit crisis - in yet another illustration of the myth of decoupling.

As reported at MarketWatch, Japan is considering lowering capital gains and dividend taxes as a way to encourage savers to move funds from lower yielding investments back into the stock market. The plan would cut dividend and capital gains taxes, potentially for up to 10 years. The proposal would temporarily exempt dividend payments of up to 1 million yen ($9,100) from taxes. An earlier plan that was passed in 2003 and cut capital gains by 50% and dividends to 10% is scheduled to expire early next year. It is hoped that the move will help spur the stock market, which has languished for over a decade. Given the level of fear in the U.S. markets, cutting capital gains by 50% and reducing dividend taxes to 10% would certainly give the U.S. markets a nice jolt. Hopefully it will not take over 10 years of poor market returns to see the need and potential benefits of such a cut. Just as the U.S. is considering higher taxes, this is yet another example of how countries around the globe are looking to reduce corporate, capital gains, and dividend taxes. Hopefully we will get the message.

Every three months after the release of quarterly data, we start to hear Congress talk about how Big Oil is making too much money and how we need to initiate some kind of windfall profits tax. Of course, when you look at the data, you see that profit margins for oil companies on a percentage basis are not stellar, or at least not exceedingly high. Compared to other industries, they are quite average. To see the data, check out Mark Perry's blog at Carpe Diem, or do a simple sector/industry sort at Yahoo! Finance.

I do sometimes wonder how many of our leaders talking about windfall profits are even looking at the data (or care to). I also wonder if they realize that when you tax something you tend to get less of it. The issue is obviously more complicated than this, but it is important to also make sure we consider the unintended consequences of our actions and decisions. Ethanol is a good example. Right or wrong, it is affecting commodity and food prices. Of course, as a trader or investor, what is important is not only noticing the obvious, but also considering the consequences. In doing so, one can use their insight to hopefully profit from the changes in the regulatory, tax, or program mandated landscape.

Just recently, those investors and traders that realized fertilizer companies would do well given the need for more corn production, or that chip makers would benefit from tax breaks to solar companies, or that the railroad companies would do better given high trucking fuel cost - along with the need to transport increased commodity production, have all profited from their knowledge and foresight. Looking out for the next "consequence" can sometimes make us profits, while easing the additional burdens we may be incurring in the rest of the market and economy. In a sense, smart investing and trading can allow us to act more like a hedge fund by increasing our returns while reducing our overall level of exposure to the market and those that control prices and policy making.