NCPA - National Center for Policy Analysis

Instant Tax Cuts Don't Always Stimulate

April 4, 2001

Some Capitol Hill politicians want to stimulate the economy by presenting taxpayers with one-time tax rebates in the neighborhood of $300 to $475 each. The idea is that Americans would run out and buy consumer goods with the extra cash, creating enough demand to pull the U.S. economy out of its current slump.

But history shows that similar windfall schemes in the past haven't necessarily accomplished their desired effect.

  • In 1964, taxes were cut steeply across the board -- but people spent only about half the extra money immediately and the move kindled inflation.
  • In 1974, taxpayers got a rebate of $100 to $200 -- with negligible impact on the economy, since three-quarters of it flowed into savings.
  • In 1992, the first President Bush ordered withholding changes without actually cutting taxes -- to the end that many taxpayers suddenly found themselves owing the government money the following year.
  • Economist Bruce Bartlett of the National Center for Policy Analysis says that the aim this year is to entice middle-class families to go out and spend their money -- since the wealthier are more likely to save the money, rather than spend it.

Rebates contradict economist Milton Friedman's permanent-income hypothesis, which holds that people spend according to their long-term income expectations, not a short-term or one-time boon.

People even take time to adjust their spending when tax-rate reductions are permanent. Economists found that consumption grew gradually over three years with the 1964 tax cut. One study found that of the extra income, 45 percent was spent in the first year -- rising to 60 percent by 1967.

Source: Shailagh Murray and John D. McKinnon, "Instant Tax Cuts to Stimulate Economy Have Fizzled or Even Backfired in Past," Wall Street Journal, April 4, 2001.

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