A Tax Rebate Won't Raise Consumption
March 28, 2001
Democrats say a tax rebate will provide the economy with a quick stimulus. We did exactly what they are recommending 26 years ago, and it had no impact on the economy.
- The Tax Reduction Act of 1975 was enacted in the midst of the deepest recession in postwar history, and checks were mailed out quickly.
- Taxpayers received a 10 percent "refund" on their 1974 taxes, with a minimum of $100 and a maximum of $200.
- This added about $8 billion to disposable income -- close, in today's dollars, to the $60 billion rebate now being proposed.
But most people didn't spend the money, and thus there really was very little economic stimulus: they saved it or used it to pay down debt.
This is explainable by the "permanent income hypothesis" developed by Nobel Prize-winner Milton Friedman. He found people tend to spend according to what they believe their permanent income is. Hence, when they got a temporary income increase, they saved it. Conversely, if they suffered a temporary income reduction, such as through a job loss, they borrowed to maintain their consumption. Only a permanent change in income, such as a permanent tax cut would significantly increase consumption.
Subsequently, a study by Franco Modigliani (another Nobel Prize winner) and Charles Steindel for the Brookings Institution found no more than one-fourth of the rebate was spent in the following three quarters.
And a 1981 study by Alan Blinder, later a Clinton appointee to the Council of Economic Advisers and the Federal Reserve Board, concluded rebates deliver just 38 percent of the impact of a permanent tax cut.
By 1978, Jimmy Carter and Congress reduced capital gains tax because they recognized that encouraging investment was a better way to increase growth than subsidizing consumption.
Source: Bruce Bartlett, senior fellow, National Center for Policy Analysis, March 28, 2001.
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