Can tax rebates really prevent an economic downturn?
by Jane McGrath
Can tax rebates really prevent an economic downturn?
Few issues have brought Republicans and Democrats together like the economic stimulus package that was pushed through the U.S. Congress with breakneck speed in early 2008. When the Chairman of the Federal Reserve Board, Benjamin Bernanke, suggested action, Bush proposed and Congress passed a bill in an effort to jolt the economy out of a period of slow growth and housing recession. One of its main purposes was to provide tax rebates to lower- and middle-income people. But how can a small windfall in your pocket jump-start the economy and prevent a country from falling into a recession?
If you've read How Recessions Work, you know that recessions often aren't diagnosed until they are well under way. So, as soon as economists start to worry, lawmakers hasten to prevent one from occurring. Just as the 2001 tax rebates seemed to help dull an impending recession, Congress is hoping they will help again in 2008.
Members of Congress want the tax rebates to prompt people to buy more goods and services and thus knock the economy back on track. If enough people quickly spend their bonus cash, it will send a boost of demand into the economy, which should then encourage companies to increase supply and create more jobs. If all works according to plan, more jobs will lead to more spending and thereby keep the economy from slipping into a recession.
The theory behind reinvigorating capitalist economies with tax rebates is a lot like the idea of overcoming static friction, which you might remember from high school physics. When economic growth is stopped, it needs a large force to get it started, which the tax rebates theoretically provide. From then on, the hope is that all it will need are free-market forces to keep it going.So how can a tax rebate plan be pushed through Congress so quickly? And how soon can you expect a check? Read on to discover how this process plays out.
How is a tax rebate plan implemented?
How Much Will You Get?
If you're still unsure of your rebate, use this tax rebate calculator from Kiplinger.com to figure it out.
Now that we know how tax rebates theoretically prevent economic downturns, let's find out how they are implemented. It may be surprising that opposing political parties can suddenly and overwhelmingly agree on something, but politicians can pass tax rebate plans quickly for a few reasons. Often, speed is necessary for the plan to work, considering the time it takes to get money to individuals. Lawmakers want people to start spending before economists can state with certainty that the nation is stuck in recession (which will cause people to hold on to their money). In addition, congressmen want to win over voters by approving bills that combat economic problems. Failing to go along with the plan might turn off voters [source: Neikirk].
For the tax rebates to work, economists say the "three T's" must fall in line. The plan should be:
The plan will have the best chance of succeeding if it comes at the right time before recession; is given to people who will spend it and doesn't have a long-term negative effect on the government [source: The Economist].
It may take as little as two to three months for rebates to arrive in mailboxes after Congress approves an economic stimulus package [source: Neikirk]. The amount you get depends on the particular plan passed. For the plan to work, Congress hopes that as many people as possible spend their money quickly.
Does that really happen? Or are people inclined to put it right back in the bank? It depends on your expectations of the economy. For instance, if you are afraid of losing your job in an impending recession, you might keep your money in savings. However, if you feel secure about your employment and the future of the economy (perhaps as a result of the tax rebate plan, itself), you might be inclined to spend it. To this extent, public perception is reality when it comes to the economy. For the rebates that were given out in the U.S. in 2001, about two-thirds were spent within six months [source: Johnson]. Those rebates may have helped to keep that recession at bay [source: Hill].
Not everyone buys this theory, however. Some argue that the 2001 rebates didn't do much to relieve the recession [source: Reidl]. Next, we'll find out why skeptics don't like the idea of tax rebates as an antidote to recession.
Criticism of Tax Rebate Plans
Learning to Repeat Past Mistakes
Political commentator Glenn Beck toys with the idea of issuing pre-paid debit cards rather than tax rebate checks. He points out that though this process proved disastrous when victims of Hurricane Katrina chose to use them on frivolous items, that same frivolous mind-set might help pump cash into the economy now. Another benefit: By putting an expiration date on the cards, people will have to spend them more quickly than they would a check or miss their opportunity.
So can tax rebates help to prevent a recession? Not necessarily. Many economists and political commentators think they merely delay an inevitable recession or even hurt countries in the long run. Here's a rundown of some objections:
- The rebate boost might act as a temporary delay for a downturn, like a pain reliever that wears off after a few hours. If individuals do spend their check quickly, a sudden increase in demand will shoot up and fade out, putting the economy back where it started and adding to the national debt (and the burden on future taxpayers).
- Even if consumers quickly blow their newfound money, the actual items people purchase might be foreign products, which wouldn't help the U.S. economy as much.
- It might be too difficult to time the rebates appropriately. The 2008 package may come too late to prevent a recession.
- Times are more troubled than they were in 2001 when a similar tax rebate measure passed. Economist Michael Niemira told the Wall Street Journal that debt has gotten so bad people will want to use their rebate check to pay off debt rather than consume more things [source: Waters].
- Tax rebates encourage spending rather than saving or investments, according to Brian Riedl of The Heritage Foundation. Riedl argues that cutting taxes to create jobs, incentives to work and investments could help the economy more significantly.
Overall, many agree that tax rebates provide at least temporary help and work best in conjunction with other fiscal and monetary policies that can help to prevent or relieve a recession. To learn more about personal finance and taxes, visit the links on the next page.
Lots More Information
Related HowStuffWorks Articles
- How Recessions Work
- How Income Taxes Work
- How much money is "all the money in the world"?
- If all the money in the U.S. only totals $6 trillion, how can the New York Stock Exchange have stocks valued at $15 trillion?
- How Banks Work
More Great Links
- Tax Rebate Calculator
- Internal Revenue Service
- Board of Governors of the Federal Reserve System
- Bureau of Economic Analysis
- Recession 411: What it is and How it Should Affect Your Investment Decisions
- Beck, Glenn. "Glenn Beck: Debit cards for everyone!" CNN.com. Feb. 12, 2008. (Feb. 15, 2008)
- Coy, Peter and Dawn Kopecki. "Looking For a Quick Fix." BusinessWeek. Feb. 4, 2008.
- The Economist. "Stampede to stimulus." Jan. 17, 2008. (Feb. 15, 2008)
- Hill, Patrice. "Stimulus package seen as cushion." Feb. 14, 2008. The Washington Times. (Feb. 15, 2008)
- Johnson, David, Jonathan Parker and Nicholas S. Souleles. "Household Expenditure and the Income Tax Rebates of 2001." September 2004. NBER Working Paper No. W10784. (Feb. 15, 2008) http://papers.ssrn.com/sol3/papers.cfm?abstract_id=593468
- Mankiw, Greg. "Proposed Fiscal Stimulus: My View." Jan. 24, 2008. Greg Mankiw's Blog. (Feb. 15, 2008) http://gregmankiw.blogspot.com/2008/01/proposed-fiscal-stimulus
- Neikirk, William. "Economic stimulus package puts President Bush, House leaders on same page." Jan. 25, 2008. Chicago Tribune. (Feb. 15, 2008) http://www.chicagotribune.com/business/chifri_stimulus
- Riedl, Brian M. "Why Tax Rate Reductions Are More Stimulative Than Rebates: Lessons from 2001 and 2003." The Heritage Foundation. Jan. 18, 2008. (Feb. 15, 2008)
- Sahadi, Jeanne. "Rebates: What you need to know." CNNMoney.com. Feb. 11, 2008. (Feb. 18, 2008)
- Samwick, Andrew A. "A Better Way to Deal With Downturns." The Washington Post. Jan. 27, 2008. (Feb. 15, 2008) http://www.washingtonpost.com/wp-dyn/content/article/2008/01/25/
- Waters, Jennifer. "Tax Rebates May Be Used To Cut Debt This Time." The Wall Street Journal. Jan. 22, 2008. (Feb. 15, 2008) http://online.wsj.com/public/article/SB120096365478305113.html