NCPA - National Center for Policy Analysis

Permanent Tax Cuts Boost The Economy

September 6, 2002

In response to the recession, the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) was enacted in June 2001. EGTRRA reduces individual tax rates, expands the child tax credit and repeals the estate tax, but these provisions are currently scheduled to expire on December 31, 2010. To stimulate both short-term and long-term economic growth, President Bush is seeking among other things to accelerate the implementation of the EGTRRA's individual income tax rate reductions and to make all of its provisions permanent.

Analysts have evaluated various options for reducing federal taxes to stimulate consumption and foster economic growth. Their findings include:

  • Individuals respond more strongly to a permanent federal tax rate reduction or other permanent tax incentives than to a temporary federal tax reduction or a federal tax rebate.
  • Thus, the duration of a federal tax reduction affects how much it can stimulate economic growth.
  • Between 50 percent and 80 percent of taxpayers spread their consumption over the their lifetime based upon their expectations of permanent income (i.e., lifetime average income excluding any one-time income gains or losses), while due to liquidity constraints, short-term thinking and other limitations many individuals (between 20 percent and 50 percent) limit their consumption to current after-tax income.
  • Since only a permanent federal tax reduction can increase permanent income, a permanent federal tax reduction elicits higher near-term consumption and Gross Domestic Product growth than a temporary federal tax reduction or rebate.

Empirical studies generally find that most of the economic benefits from federal tax reductions occur when they're implemented, not when they're announced. Conversely, lengthy phase-ins and implementation delays minimize the near-term boost to consumption and GDP.

Source: Robert P. O'Quinn, "The Effects of the Duration of Federal Tax Reductions: Examining the Empirical Evidence," Joint Economic Committee of Congress, February 2002.

 

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