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Tax Cut Plan May Have Little Impact on U.S. Economy

7/31/2003 --

ANN ARBOR, Mich.---As the mailing of $400-per-child tax-rebate checks to millions of American homes continues, University of Michigan economists are skeptical that such cuts will lead to a surge of increased spending and economic stimulus.

Tax expert Joel Slemrod, professor of business economics and public policy at the Michigan Business School and director of the U-M Office of Tax Policy Research, believes that economic conditions are not much different now than they were in 2001 when passage of President Bush’s 10-year tax-cut bill resulted in immediate tax rebate checks for many Americans. The bill was designed to encourage consumers to increase spending and provide a short-run stimulus to the U.S. economy to help lift the nation out of recession.

“Debt as a percentage of personal disposable income is at a post-war high, and the Index of Consumer Sentiment, conducted each month by the University of Michigan, still has not recovered to the 2000 level,” Slemrod said. “In addition, the nation’s unemployment rate continues to rise and the public in general is skeptical about the federal government’s mounting budget deficit. Many feel uncertain about whether the tax cuts will remain in place, or be withdrawn in just a few years when conditions change.”

In addition to the rebate checks for people who get child credits, current federal tax relief also includes decreases in withholding amounts for workers with wages and salaries, and lower tax rates on dividends and capital gains.

“Politicians are a lot more sanguine about using tax cuts as a stimulus policy than economists are,” Slemrod said. “I don’t doubt the GDP is somewhat higher because of the 2001 tax cuts, but the problem is that this approach is not without costs. If you cut taxes without cutting spending, the government eventually has to raise taxes later. Therefore, a tax cut is not a cost-free solution to sluggish economic performance.”

Studies conducted in 2001 and 2002 by Slemrod and University economist Matthew Shapiro found that fewer than expected households said the tax rebate would lead them to increase their spending. In other words, taxpayer response constrained the amount of economic stimulus generated by the Economic Growth and Tax Relief Reconciliation Act of 2001.

By comparison, a 1992 change in standard income tax withholding amounts revealed a 43 percent spend rate. However, in 2001, only 22 percent of the households surveyed indicated that they would mostly boost spending as a result of the tax rebate. Shapiro and Slemrod reconfirmed this most recent figure in three separate surveys, including one conducted during the 2001 rebate period, a follow-up six months later and a third after the attacks of 9/11. All survey results indicated the same low spend rates.

“I don’t know exactly why the spend rate was so much lower in 2001,” Slemrod said. “My hunch is that it is because the stock market had been coming down for a year and the economic outlook was very uncertain. Most taxpayers were concerned that their personal debt and savings were out of whack. Of course, people had the option of cutting down on spending, but this is very difficult. So they found it convenient to use their tax rebates to pay down debt or to shore up savings.”

Slemrod and Shapiro plan to conduct another study, due out this fall, to examine consumer response to the first two of this year’s three tax breaks.

For more information, contact:
Bernie DeGroat
Phone: 734.936.1015 or 734.647.1847
E-mail: bernied@umich.edu