Tax Cuts and Economic Stimulus: How Effective Are the Alternatives?

Publication Date: January 2003

Publisher: Library of Congress. Congressional Research Service

Author(s):

Research Area: Economics

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Abstract:

Several different types of tax cuts have been debated during the consideration of the fiscal stimulus bills. Among tax cuts discussed in the 107th Congress were tax rebates targeted towards lower income individuals, a speed-up of already planned tax rate reductions for higher income individuals, a temporary sales tax holiday, a temporary payroll tax holiday, a temporary investment stimulus (which was ultimately included in H.R. 3090. the stimulus bill enaced in March of 2002), and corporate tax cuts (primarily repealing the alternative minimum tax). President Bush has proposed accelerated rate cuts and dividend relief in his stimulus package, while proposals such as rebates have been made by Democratic leaders.

A tax cut is more effective the greater the fraction of it that is spent. Empirical evidence suggests individual tax cuts will be more likely to be spent if they go to lower income individuals, making the tax rebate for lower income individuals likely more effective than several other tax cuts. There is some evidence that tax cuts received in a lump sum will have a smaller stimulative effect than those reflected in paychecks, but this evidence is limited and the results subject to some reservations. While temporary individual tax cuts in general are likely to have smaller effects than permanent ones, temporary cuts that are contingent on spending (such as temporary investment subsidies or a sales tax holiday) are likely more effective than permanent cuts. (Sales tax holidays may, however, be very difficult to implement in a timely fashion). The effect of business tax cuts is uncertain, but likely to be quite small for tax cuts whose main effects are through cash flow. This report will be updated as events warrant.