The Electric Commentary

Saturday, January 26, 2008

Will Tax Rebates Stimulate The Economy?

Probably not.

To understand why we have to think about incentives. This tax rebate is being proposed in an attempt to turn around a slowing economy. (Or, if you're more cynical, because it is an election year.) By giving out this tax rebate, the government is acknowledging that it is concerned about the state of the economy. Your average Joe will probably agree, having been berated about stagnant wages, health care costs, inflation, and the "sub-prime crisis." (Note, by the way, that tax cuts alone do not cause inflation as those dollars were backed by production when they were earned. Tax cuts can, however, lead to inflation. We'll get to that in a bit.)

Since we're dealing with macro here, let's stipulate that people will act rationally, in their own self interest. People have been told that the economy is bad, and the government believes this so much that they actually sent out a check. People also are at least vaguely aware that government spending has skyrocketed under this administration, and that the size of the debt has skyrocketed along with it.

You are essentially telling people that unemployment might go up. This is an incentive to save. Since this tax cut will increase the size of the deficit, you are telling them that there will either be a tax increase or inflation in the future, as these are the only two means available to the government to pay back their debts. This is an incentive to save. Actions like this make people nervous, and when people are nervous, they buy fewer plasma TVs. They do not stimulate the economy.

The government claims that it wants people to spend this rebate to stimulate the economy, however, the government has created incentives for people to save this money. There is nothing wrong with saving, of course, but saving is unlikely to have the desired effect.

For the record, I am not against tax cutting, however, if the government does not cut a corresponding chunk of spending, a tax cut is simply a deferred tax increase. George W. Bush has increased taxes more than almost any other president. He is simply going to leave the messy bit to one of his successors.


  • I agree with you, this stimulus is odd, small, and unlikely to do much, although I think it might be a little stronger than you predict.

    Some people will spend the rebate, thereby increasing consumption, which will increase GDP (although perhaps only a very, very little bit). Although government spending also increases GDP, it can't realistically do it in the same, one time fashion that the rebates allow for (but do not gaurantee).

    Even if people save and maybe even if they pay off credit card debt, that is money that will go to a battered financial industry, which needs cash right now, at least according to the hype.

    As you say, it might just be a drop in a bucket does not get poured out into the GDP stream, especially with a huge budget defecit looming large.

    Still, considering alternatives, I kind of like this right now, because it gets people thinking the government is doing something (and they are), it might work, and at least it isn't a monster Keynsian Government works project. (Which I actually would support if things were really, really bad and the prime rate was already at 0).

    Also, I want my $600, because I want to buy an X-Box 360 and the game "Gears of War," which is excellent.

    By Anonymous Anonymous, at 11:59 AM  

  • I think that your points are all good ones, this cut will do something, just not much. There are better alternatives out there, as I've been scouring the econ blogs. Perhaps in the next post.

    By Blogger PaulNoonan, at 2:21 PM  

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