May 16, 2001

May 16, 2001 | Commentary on Taxes

Shelve the Rebates and Bring on the Rate Cuts

In an effort to jumpstart our flagging economy, the Federal Reserve has just lowered interest rates yet again. Good idea.

But now some in Congress think they can go the Fed one better and stimulate the economy by delivering the $100 billion they've set aside for immediate tax relief in the form of rebate checks to every taxpayer. Bad idea.

Sure, it has curb appeal. Rebate advocates argue that these checks, which would range from $300 to $400, are the way to go because they would put money directly into the hands of consumers, who would then put that money into the hands of merchants. The merchants, in turn, would hire more people and buy more inventories. Everyone's happy.

But in the long run -- and, frankly, even in the short run -- a "rebate now, maybe a rate cut later" tax agenda adds up to poor economic policy. We in The Heritage Foundation's Center for Data Analysis know, because we've run the numbers.

Using the same economic model used by many Fortune 500 companies, we compared a rebate program that would pay $52 billion this year and $51 billion next year with a similar-sized tax rate reduction over the same period. And while the rate cut doesn't offer the pleasure of finding a check in your mailbox, it fared better in every other area.

Start with jobs. The rate cut would produce 180,000 jobs in the first year and 352,000 over two. Compare that with the rebate, which would generate only 70,000 jobs the first year and 158,000 over two. That's less than half as many. Advantage: rate cut.

Job growth is one thing, you say, but what about consumer spending? Surely, we'll all take our $300 or so to the local Circuit City or Wal-Mart and spend until the economy is back to its robust self, right? But again, rate cuts fare better. Our analysis found that the cuts would spark $38 billion in additional spending, compared to $33 billion for rebates.

As for the stock market, it's no secret that investors prefer the long-term soundness of rate cuts to the short-term bump of rebates. And the numbers bear out their judgment: According to our analysis, rate cuts would generate $7.6 billion in new investment -- $2.4 billion more than rebates would bring.

Total up all the numbers, and rate cuts look even better. By the end of 2011, gross domestic product would be $95.9 billion higher -- a huge improvement over the $5.2 billion boost in GDP we'd see with rebates. Unemployment would be even lower than Congress is now estimating, with 1.6 million more Americans working, thanks to the increased productivity that rate cuts would unleash.

And how would family income be affected? That would go up, too. A family of four would have $4,644 more by the end of 2011 than they'd have under rebates. In response to this increase in the family budget, we found consumer spending would rise by $257 billion, or $3,422 for each family of four. These families would save more as well: Within a decade, they'd have $1,087 more in the bank than they would with rebates.

Why the difference? Because, as shown by the Kennedy tax cuts in the 1960s and the Reagan tax cuts in the 1980s, tax-rate cuts encourage people to produce more. Economic growth comes not from "putting more money in people's pockets," but from refusing to penalize those who would start new businesses or expand their current ones. Economic output goes up under rate cuts because there's more income available to spend, save and invest.

That a rebate, no matter what its size, wouldn't do much to stimulate the economy shouldn't surprise anyone, because it's really the same as a government spending program. Tax relief occurs when government doesn't take money from people in the first place. A spending program occurs when the government collects money and then gives it to someone. Congress can call the rebates a "tax cut," but that wouldn't change the fact that the money is cycled through Washington and therefore amounts to government spending.

Despite this, rebates may still strike some lawmakers as an attractive option, at least politically. After all, wouldn't it be nice to tell voters they'll be getting a nice surprise in their mailboxes? But this is one tax proposal that needs to be marked: "Return to sender."

William Beach is director of the Center for Data Analysis at The Heritage Foundation. Mark Wilson is a former research fellow in Heritage's Roe Institute for Economic Policy Studies.

About the Author

William W. Beach Director, Center for Data Analysis and Lazof Family Fellow
Center for Data Analysis

Related Issues: Taxes

Distributed nationally by Knight-Ridder Tribune News Service