Democrats in the United States say a tax rebate will provide the economy with a quick stimulus. The U.S. did exactly what they are recommending 26 years ago, and it had no impact on the economy.
But most people didn’t spend the money, and thus there really was very little economic stimulus: they saved it or used it to pay down debt.
This is explainable by the “permanent income hypothesis” developed by Nobel Prize-winner Milton Friedman. He found people tend to spend according to what they believe their permanent income is. Hence, when they got a temporary income increase, they saved it. Conversely, if they suffered a temporary income reduction, such as through a job loss, they borrowed to maintain their consumption. Only a permanent change in income, such as a permanent tax cut would significantly increase consumption.
Subsequently, a study by Franco Modigliani (another Nobel Prize winner) and Charles Steindel for the Brookings Institution found no more than one-fourth of the rebate was spent in the following three quarters.
And a 1981 study by Alan Blinder, later a Clinton appointee to the Council of Economic Advisers and the Federal Reserve Board, concluded rebates deliver just 38 percent of the impact of a permanent tax cut.
By 1978, Jimmy Carter and Congress reduced capital gains tax because they recognised that encouraging investment was a better way to increase growth than subsidising consumption.
Source: Bruce Bartlett, senior fellow, National Center for Policy Analysis, March 28, 2001.
For text http://www.ncpa.org/oped/bartlett/bartlett01.html
For more on Current Tax Legislation
http://www.ncpa.org/pi/congress/cong2.html
