Tax cuts vs. tax rebates

Tax rebates – like those being discussed by US 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 behaviour; 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, business investment had plummeted, the stock market had dropped 18 per cent, 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 per cent, 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.

For text: http://www.washingtontimes.com/article/20080116/COMMENTARY/260245673/1012

For more on Taxes: http://www.ncpa.org/sub/dpd/index.php?Article_Category=20

FMF Policy Bulletin/ 22 January 2008