Tax Rebates

TAX REBATES….Bruce Bartlett takes to the pages of the Wall Street Journal to warn us that while a one-shot tax rebate in April might make us all feel good, it won’t actually stimulate the economy much because people are unlikely to spend more than a small portion of it. At least, that’s what Milton Friedman argued when Gerald Ford tried a tax rebate during the 1974 recession:

[Friedman’s] research had led him to conclude that consumer spending was less a function of liquidity than something he called “permanent income.” Friedman observed that when workers lost their jobs, they didn’t immediately cut back on spending. They borrowed or drew down savings to maintain spending, in the expectation of finding a new job shortly. Conversely, consumers didn’t immediately spend windfalls. They kept spending on an even keel until they achieved a promotion at work, or other increase in their long-term income expectations.

….Subsequent studies by MIT economists Franco Modigliani and Charles Steindel, and Alan Blinder of Princeton, showed that Friedman’s prediction was correct. The 1975 rebate had very little impact on spending and much less than a permanent tax cut — which would change peoples’ concept of their permanent income — of similar magnitude.

The problem, of course, is that we can’t cut taxes permanently every time we enter a recession. Pretty soon no taxes would be left — and while that might make Ron Paul happy, the rest of us would probably prefer to keep a functioning government on hand.

But why not try a compromise? Instead of, say, a one-shot rebate of $1,200, why not a monthly rebate against payroll taxes of $100 for 12 months? Add to that a 12-month boost to unemployment compensation, and you’d get a short term increase for everyone who works as well as for those temporarily idled by the recession.

Sure, a permanent increase might be psychologically superior, but knowing that you were going to get a steady stream of money for 12 months might prompt a little more spending confidence than a one-time windfall. Why not give it a try?