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
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.
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
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
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
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.
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
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. The simple redistribution from investment to consumption did not create new wealth.
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
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:
- GDP grew at an
annual rate of just 1.7 percent in the six quarters before the 2003 tax
cuts. In the six quarters following the tax cuts, the growth rate was
- Non-residential fixed investment declined for 13
consecutive quarters before the 2003 tax cuts. Since then, it has
expanded for 13 consecutive quarters.
- The S&P 500 dropped
18 percent in the six quarters before the 2003 tax cuts but increased
by 32 percent over the next six quarters. Dividend payouts increased as
- The economy lost 267,000 jobs in the six quarters before
the 2003 tax cuts. In the next six quarters, it added 307,000 jobs--and
5.3 million jobs over 13 quarters.
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.
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
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.
 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).
 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)," here. (January 16, 2007).