Does Washington Pump-Priming Work?

One-time tax cuts and rebates provide little bang for the buck.


Former Clinton Treasury Secretary Larry Summers, as well as some Democrats, have advocated temporary tax cuts or rebates to boost consumer spending to help avoid a recession this year. Milton Friedman's "permanent income" hypothesis argues that such moves don't provide much bang for the buck. Friedman theorized that people take long-term views of their financial situation and won't spend one-time bonanzas.

Well, a new study from the Federal Reserve Bank of Chicago, the University of Nevada-Reno, and the Wharton business school looked at what consumers did with the 2001 federal income tax rebates. Specifically, to what extent did consumers use the $38 billion in rebates—typically $600 for couples and $300 for singles, for an average gain of about $500 per household—to increase spending or pay down debt? The study found the following:

On average, consumers initially saved some of the rebate, by increasing their credit card payments and thereby paying down debt and increasing their liquidity. But soon afterwards their spending increased.... For consumers whose most intensively used credit card account is in the sample, spending on that account rose by over $200 cumulatively over the nine months after rebate receipt, which represents over 40 percent of the average household rebate. [The results] represent compelling evidence of a causal link from the rebate to spending.

Well, kind of. Basically, the study found that some consumers spent 40 percent of the rebate; most spent less, if any. If anything, the study hints that the 2001 tax cuts and the 2003 should have been done in reverse order given the way the economy boomed after 2003 and lurched forward after 2001. More important, what would be the impact today of temporary fiscal stimulus—whether in the form of tax cuts, rebates, or more government spending—vs. long-term policies that would improve the productive potential of the economy and its fiscal outlook? Sure the latter is harder, but that's what Washington is supposed to be doing, yes?

tax returns

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