NCPA - National Center for Policy Analysis

TAX CUTS VS. TAX REBATES

January 17, 2008

Tax rebates -- like those being discussed by Congressional leaders -- fail to stimulate the economy because they don't encourage productivity or wealth creation.  No one has to work, save, invest or create any new wealth to receive a rebate, says Brian M. Riedl, the Grover M. Hermann Fellow at the Heritage Foundation.

Consider:

  • Critics contend that rebates "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 (and even money borrowed from foreigners reduces net exports).
  • No new spending power is created; it is merely redistributed from one group of people to another.

Take the 2001 tax rebates, for example:

  • Washington borrowed billions from the capital markets, and then mailed it to families in the form of $600 checks.
  • Predictably, consumer spending temporarily rose, and capital/investment spending temporarily fell by a corresponding amount.
  • This simple transfer of existing wealth did not encourage productive behavior; the economy remained stagnant through 2001 and much of 2002.

It was not until the 2003 tax cuts -- which instead cut tax rates for workers and investors -- that the economy finally and immediately recovered:

  • In the previous 18 months, businesses investment had plummeted, the stock market had dropped 18 percent, and the economy had lost 616,000 jobs.
  • In the 18 months after the 2003 tax rate reductions, business investment surged, the stock market leaped 32 percent, and the economy created 5.3 million new jobs; overall economic growth doubled.

Thus, both economic theory and practice show the superiority of tax rate reductions over tax rebates, says Riedl.

Source: Brian M. Riedl, "Tax cuts vs. tax rebates," Washington Times, January 16, 2008.

 

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