Posted on 01/19/2008 10:40:22 AM PST by wagglebee
With slower economic growth raising fears of a recession, Washington is abuzz with economic stimulus proposals centered on tax rebates. Tax rebates, however, don't stimulate the economy. Lawmakers currently examining economic stimulus proposals should reject rebates in favor of tax rate reductions.
Tax Rebates Don't Stimulate
By definition, an economy grows when it produces more goods and services than it did the year before. In 2007, Americans produced $13 trillion worth of goods and services, up 3 percent over 2006.
Economic growth requires four main factors: (1) an educated, trained, and motivated workforce; (2) sufficient levels of capital equipment and technology; (3) a solid infrastructure; and (4) a legal system and rule of law sufficient to enforce contracts and contain a functioning price system.
High tax rates reduce economic growth, because they make it less profitable to work, save, and invest. This translates into less work, saving, investment, and capital--and ultimately fewer goods and services. Reducing marginal income tax rates has been shown to motivate people to work more. Lower corporate and investment taxes encourage the savings and investment vital to producing more and better plants, equipment, and technology.
By contrast, tax rebates fail, because they do not encourage productivity or wealth creation. To receive a rebate, nobody has to work, save, invest, or create any new wealth.
Supporters of rebates argue that they "inject" new money into the economy, increasing demand and therefore production. But every dollar that government rebates "inject" into the economy must first be taxed or borrowed out of the economy. No new spending power is created. It is merely redistributed from one group of people to another. (Even money borrowed from foreigners brings a reduction in net exports.)
Supporters of rebates respond that redistributing money from "savers" to "spenders" will lead to additional spending. That assumes that savers store their savings in mattresses, thereby removing it from the economy. In reality, nearly all Americans either invest their savings (which finances business investment) or deposit it in banks (which quickly lend it to others to spend). Therefore, the money is spent whether it is initially consumed or saved. Given that reality it is more responsible to let the savers keep that money for a new home or their children's education, rather than to have Washington redistribute it to someone else to spend at Best Buy.
Simply put, low tax rates encourage working, saving, and investing, which in turn encourages job creation and wage growth. Tax rebates merely redistribute existing wealth.
The Failed 2001 Tax Rebates
While the 2001 tax cuts reduced some marginal tax rates, the centerpiece was tax rebates. These rebates were rationalized as a pre-payment of the reduction of the lowest marginal income tax bracket from 15 percent to 10 percent. Yet because they were not based on encouraging productive behavior, the rebates had little economic impact.
In the spring and summer of 2001, Washington borrowed billions from the capital/investment markets, and then mailed it to families in the form of $600 checks. In the fourth quarter of that year, consumer spending responded with 7 percent annualized growth, and investment spending correspondingly decreased by 23 percent. The economy grew at a sluggish 1.6 percent annualized rate.[1] The simple redistribution from investment to consumption did not create new wealth.
All traces of the rebate policy effectively disappeared by the next quarter. Consumer spending retreated to 1.4 percent annualized growth, and investment spending partially recovered from its steep decline with a 13.6 percent annual growth. The economy remained stagnant through much of 2002.
The Successful 2003 Tax Rate Cuts
By contrast, the 2003 tax cuts lowered income, capital gains, and dividend tax rates. These policies were designed to increase market incentives to work, save, and invest, thus creating jobs and increasing economic growth. An analysis of the six quarters before and after the 2003 tax cuts (a short enough time frame to exclude the 2001 recession) shows that the policies worked:
Critics contend that the economy was already recovering and that this strong expansion would have occurred even without the tax cuts. While some growth was occurring naturally, critics do not explain why such a sudden and dramatic turnaround began at the exact moment that these pro-growth policies were enacted. They do not explain why business investment, the stock market, and job numbers suddenly turned around in spring 2003. It is no coincidence that the expansion was powered by strong investment growth, exactly as the tax cuts intended.
Conclusion
The 2003 tax rate cuts succeeded, because they increased incentives to work, save, and invest, thereby creating new wealth. The 2001 tax cuts, based more on demand-side tax rebates and redistribution, did not significantly increase economic growth. Lawmakers currently examining economic stimulus proposals should reject rebates in favor of tax rate reductions.
Brian M. Riedl is Grover M. Hermann Fellow in Federal Budgetary Affairs in the Thomas A. Roe Institute for Economic Policy Studies at The Heritage Foundation.
[1]U.S. Commerce Department, Bureau of Economic Analysis, NIPA Tables, Table 1.1.1, at www.bea.gov/bea/dn/nipaweb/SelectTable.asp (January 18, 2008).
[2]U.S. Commerce Department, Bureau of Economic Analysis, NIPA Tables, Table 1.1.1, revised, at www.bea.gov/bea/dn/nipaweb/SelectTable.asp (January 16, 2007); Yahoo Finance, "S&P 500 Index," at www.finance.yahoo.com/q/hp?s=%5EGSPC (January 16, 2007); and U.S. Department of Labor, Bureau of Labor Statistics, "Employment, Hours, and Earnings from the Current Employment Statistics survey (National)," at http://data.bls.gov/PDQ/servlet/SurveyOutputServlet?data_tool=latest_numbers&series_id=CES0000000001&output_view=net_1mth (January 16, 2007).
Excellent analysis!
“Rebate” or preturn?
The Democrats don’t want to hear it. The facts conflict with their socialist, “soak the ‘rich’” mentality.
“”Tax Rate Reductions Are More Stimulative Than Rebates: Lessons from 2001 and 2003””
It may be technically correct to say that rate reductions are more stimulative than rebates but the reality is that rebates stimulate the economy faster than rate cuts. The good news about the way things are going is that there will be some sort of plan to return money to the taxpayers to stimulate the economy. Thats much better than the Democratic scheme of stimulating the economy by more direct government spending programs.
What they need to do is both and do it immediately.
Yeah, you’re right, but the Democrats control Congress and would never allow tax rate cuts now. What we’ve got to do is use a successful stimulus package to win the 2008 election and then push for tax rate cuts with a Republican POTUS and Republican House of Representatives in 2009.
The problem with rebates now is that BOTH the ‘Rats and Bush can claim credit for them AND the ‘Rats will be able to say that the only reason they are necessary is because of Bush’s economic policies.
Great post.
Rebates are one-offs, whereas tax rate reductions have at least a chance of an extended life. Also, lower tax rates encourage long-term saving.
Government can collect higher gross taxes by lowering tax rates.
“”The problem with rebates now is that BOTH the ‘Rats and Bush can claim credit for them AND the ‘Rats will be able to say that the only reason they are necessary is because of Bush’s economic policies.””
True...but the situation would be much worse if we went into the heart of the election season with a recession and no immediate stimulus in place.
Very true, the GOP will at least be able to claim that the problem has been alleviated.
it does not fit the lib/dem agenda......rebates go to those that do not pay taxes....tax rate reductions go to people that don’t vote lib/dem!!!!
True. What really stimulates the economy is the confidence of business to invest and consumers to spend. To the extent that spending is on imports, it has a lesser effect on the domestic economy. If people think the Government is coming to the rescue, they will spend more - probably more than the Government was going to give them anyway. So the result is more consumer debt and a higher trade deficit.Thats much better than the Democratic scheme of stimulating the economy by more direct government spending programs.
Yes. I heard on the radio yesterday that Hillary wants to provide Government subsidies for "Green Collar" jobs to develop renewable energy projects. Even if this was a good investment by Government, it's a loser from the objective of an economic stimulus. Any development would involve a relatively small number of people and would take years to bring products to market. Then the products would cost more than what consumers are spending now. It may turn out to have been a good long term investment 10-20 years from now but it's a negative as a short turn stimulus.
Rebates do not stimulate the economy. How could they? Money that would have been spent by the government is rebated to the taxpayers who will spend it instead. It's always preferable that the taxpayers spend the money but the wealth that money represents has already been created.
No new wealth created = no stimulus. This is pure election year pandering.
The terminology is significant, too. Rebate or refund indicates the government regards the funds as theirs even though they didn't generate it.
Rebates do not stimulate the economy. How could they? Money that would have been spent by the government is rebated to the taxpayers who will spend it instead.
San Fran Nanny Democrat fascists aren’t interested in the welfare of the poeple they are only interested in controlling people.
Look and see how they propose to ‘fix the problem’ for details.
lotsa good analysis around a simple fact:
“every dollar that government rebates “inject” into the economy must first be taxed or borrowed out of the economy.”
“”Rebates do not stimulate the economy. How could they? Money that would have been spent by the government is rebated to the taxpayers who will spend it instead.””
Thats not true!!! The money WAXS NOT going to be spent by the government...as a matter of fact, the budget doesn’t call for the money to be spent at all. By pumping this money back into the economy, the governemnt will ADD $145 billion to the deficit and it will increase our debt by that much.
“”Thats not true!!! The money WAXS NOT going to be spent by the government...””
Oops, a typo. This should read, “Thats not true!!! The money WAS NOT going to be spent by the government...”
My big fat fingers sometimes hit two keys instead of one.
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