Both houses of Congress recently completed their
work on the budget resolution for fiscal year (FY) 2002. In addition to
increasing federal spending, Congress has voted to return $100
billion in excess tax revenues, spread across this fiscal year and
FY 2002, to those who pay income or payroll taxes. This is good
news for nearly every American household; the tax relief should
help the flagging economy if it focuses on increasing the
incentives to work and save--in other words, if Congress delivers a
tax relief package in a way that will reinforce the capital heart
of the economy.
Although policymakers are eager to provide
immediate tax relief to help stimulate the economy, a number of
politicians want to deliver it through tax rebates instead of lower
tax rates. Having the federal government send checks to people,
however, will do far less to help the economy than can be done by
reducing their tax rates. In addition to being bad economic policy,
as history has shown, rebates also are bad tax policy. If lawmakers
genuinely want to increase the economy's performance, they should
use the money policymakers are considering for rebates to make
further permanent reductions in tax rates on work, saving, and
investment.
Because the budget resolution (H. Con.
Res. 83) calls for $100 billion in immediate tax relief but does
not direct how this relief should be delivered, Congress faces a
choice: Either have the government send checks to selected
beneficiaries (a rebate) or endorse sound tax policy and make a
downpayment on long-term tax reform by cutting tax rates and making
other needed, pro-growth tax policy changes.
If
Congress chooses tax rate reductions and uses the $100 billion to
accelerate tax relief and make the reductions retroactive to
January 1, 2001, the effect on the economy will be significant.
Calculations by analysts in The Heritage Foundation's Center for
Data Analysis indicate that:
-
The retroactive rate reductions would lift
the economic growth rates for 2001 and 2002 by 0.1 percentage point
and 0.4 percentage point, respectively.
-
The combination of lower tax rates and the
repeal of death taxes, marriage penalty reform, and an expanded
child tax credit would
produce 1.6 million more jobs over the next 11 years, compared with
economic forecasts under current tax law.
-
Over $100 billion in tax relief could be
delivered to taxpayers through tax rate reduction alone in FY 2001
and FY 2002.
- Some 352,000 more Americans would have
jobs by the end of FY 2002, compared with an increase of only
158,000 jobs if excess taxes are returned in the form of a
rebate.
From
a political perspective, tax rebates are attractive since
constituents would get a check in the mail. But rebates have little
economic impact. Choosing rebates over further tax rate reductions
would squander an opportunity for Congress and the President to
boost both short- and long-term economic performance with sound tax
policy.
| How Tax Rate Reductions vs. Rebates Would
Affect the Economy
Some advocates of returning excess tax revenues to taxpayers
through rebates believe that this method is just as effective in
stimulating economic activity as is making reductions in marginal
tax rates. However, a test of these two approaches using the WEFA
U.S. Macroeconomic Model showed that a tax rate reduction would do
much more for the economy than would rebates of equal size, even
over a period of just two years.
Heritage analysts simulated a rebate program that paid out $52
billion in FY 2001 and $51 billion in FY 2002, and compared that
simulation with one of a tax rate reduction of $52 billion and $51
billion, respectively, in those same years. The results of this
comparison are most instructive.
-
In FY 2001, tax rate reductions
produce over twice the number of jobs than the rebate method:
180,000 vs. 70,000.
-
This increase in jobs would
continue. By the end of the second year, almost twice as many new
job opportunities would be created with rate reductions than with a
rebate. In FY 2002, 352,000 more Americans would have jobs after
rate cuts, compared with 158,000 more with rebates.
-
Consumption expenditures would be
higher following a rate cut than they would be after a rebate: $38
billion more vs. $33 billion more (after inflation
adjustments).
-
The growth of inflation-adjusted
investment would be higher with a tax rate reduction than with
rebates: $7.6 billion vs. $5.2 billion.
- Over the long run, the economic impact of tax rate reductions
is significantly larger than the ephemeral effect of rebates. By
the end of FY 2011, the gross domestic product (GDP), adjusted for
inflation, would be $95.9 billion higher with tax rate relief
com
|
WHAT'S WRONG WITH TAX REBATES
A
one-time payment from the government is not a tax cut and will do
little to stimulate the economy. Instead, a tax rebate is a
throwback to the failed fiscal policies of the 1970s. The evidence
shows, for instance, that the Gerald Ford tax rebate did not help
the economy, and the same type of policy will not help today. More
specifically:
Rebates have little stimulative effect
on the economy. Tax rebates, a throwback to widely discredited
Keynesian economic theory, are based on the notion that the
government can jump-start the economy simply by putting money in
people's pockets. According to this theory, people will spend the
money, and the increase in the demand for goods and services will
ripple through the economy, leading to more jobs and increased
economic output.
If
Keynesian economics had any validity, the U.S. economy would have
boomed in the 1970s after the 1975 rebate was enacted. Researchers
failed to find any beneficial impact from that rebate, however, and
President Jimmy Carter withdrew a similar proposal in 1977 when the
Democrat-controlled Congress criticized it as being an ineffective
economic stimulant. Moreover, the
Japanese government enacted a whole series of Keynesian "stimulus"
packages in the past decade that resulted in a 10-year economic
stagnation, not economic growth.
Even
if Keynesian theory were correct, it would be impractical because
the money that the government would give consumers must come from
somewhere. In the 1970s, the tax rebate was financed by deficits,
which meant that there was less money available for investment
spending. The result: no increase in aggregate spending. Today, in
a budget surplus environment, a tax rebate does mean less debt
reduction; but this simply means that the government is taking
money that would have been put in the "pockets" of bondholders and
putting it in the "pockets" of rebate recipients instead. Again,
the result is no increase in aggregate demand or total
spending.
Rebates are really a form of government
spending. It should not be surprising that rebates have little
stimulative effect, because a rebate is really the same as a
government spending program. Tax relief occurs when government does
not take money from people in the first place. A spending program
occurs when the government collects money and then gives it to
someone. Even if policymakers decide only to give rebate checks to
taxpayers, this does not change the fact that the money is cycled
through Washington and therefore represents government
spending.
Indeed, the Senate Budget Committee
acknowledged this fact when the original Senate budget resolution
was adopted on April 6, 2001. In their technical analysis, the
rebate was counted as spending in Budget Function 920 (Allowances)
instead of being added to the tax cut totals.
Supply-side tax policy is the way to
boost economic growth. Supply-side economics recognizes that
tax rate reductions help the economy by encouraging people to
produce more. The economic stimulus occurs because the tax penalty
on productive behavior is reduced, not because there is more money
in people's pockets. In other words, when lawmakers reduce marginal
tax rates on work, saving, investment, and entrepreneurship, people
have an incentive to produce more, which means more economic output
and therefore more income available for both consumption and
savings.
This
explains why supply-side tax cuts, such as the Kennedy tax cuts in
the 1960s and the Reagan tax cuts in the 1980s, are associated with
economic expansions. The lower tax rates--as well as substantial
reductions in the tax burden imposed on business--encouraged
workers, savers, investors, and entrepreneurs to engage in
additional productive behavior. More jobs were created and incomes
rose.
HOW TAX CUTS COULD BOOST ECONOMIC
ACTIVITY
Congress can implement the tax relief
called for in the FY 2002 budget resolution by combining the tax
rate reductions in the Economic Growth and Tax Relief Act of 2001
(H.R. 3) with substantial death tax relief and marriage penalty
reductions. This sound approach to tax policy would permanently
lower tax rates on work, saving, and investment. Moreover, if
policymakers made all of the tax rate reductions in H.R. 3
retroactive to January 1, 2001, they would provide $103 billion in
tax relief from FY 2001 to FY 2002 without having to resort to tax
rebate gimmicks.
To
understand how the economy would respond to lower tax rates,
Heritage economists used the WEFA U.S. Macroeconomic Model to conduct a
dynamic simulation of the legislation. They reconstructed WEFA's
December 2000 long-term model to embody the economic and budgetary
assumptions published by the Congressional Budget Office (CBO) in
January 2001. These are the same economic assumptions that Congress
adopts when it frames and passes its annual budget resolution. This
specifically adapted model then uses CBO budget assumptions to
produce dynamic simulations of policy changes.
The
Heritage dynamic analysis shows that lower tax rates would:
-
Increase economic growth. Lower income
tax withholding in the second half of 2001 and additional tax rate
reductions in 2002 would increase the rate of economic growth by
0.1 percentage point this calendar year and 0.4 percentage point in
2002. By the end of FY 2011, GDP (adjusted for inflation) would be
$248 billion higher than the CBO baseline forecast without the tax
policy change.
-
Create more job opportunities. Over
1.6 million more Americans would be working at the end of FY 2011,
compared with the CBO baseline forecast. Moreover, the unemployment
rate would average just 4.7 percent instead of 4.9 percent from FY
2001 to FY 2011.
-
Increase family income. By the end of
FY 2011, real disposable personal income (income after taxes,
adjusted for inflation) for a family of four would increase by
$4,644. In response to this
increase in family budgets, consumer spending would rise by $257
billion, or $3,422 for each family of four.
-
Increase family savings. By the end of
FY 2011, a family of four would be able to save $1,087 more
(adjusted for inflation) than the CBO baseline forecast. This higher level
of personal savings is reflected in a higher savings rate, which on
average is 0.7 percentage point above the baseline forecast of the
CBO without the tax policy change.
- Increase investment. Investment
(adjusted for inflation) would increase by an average of $46
billion per year from FY 2001 to FY 2011. By the end of FY 2011,
the net capital stock would be $315 billion higher.
CONCLUSION
Rebates will not stimulate the economy as
much as will marginal tax rate reductions. Tax rebates may be
attractive from a political perspective, but they have little
economic impact. Congress and the President should boost short-term
and long-term economic performance by adopting sound tax policy:
specifically, by cutting marginal tax rates.
Supply-side tax policy is the way to boost
economic growth. Tax rate reductions help the economy by
encouraging people to produce more. When lawmakers reduce the
penalty on work, saving, investment, and entrepreneurship, people
have a greater incentive to produce more. Policymakers should
ignore the siren song of rebates and pursue sound tax policy that
lowers tax rates across the board and leads to economic growth,
more job opportunities, and increased investment.
William
W. Beach is Director of the Center for Data Analysis, and
D. Mark Wilson is a former Research Fellow in the Thomas A. Roe
Institute for Economic Policy Studies, at The Heritage
Foundation.
Endnotes