Tax cut may have little impact

U-M economists are skeptical that tax cuts, like the recent $400-per-child tax-rebate checks mailed to millions of Americans, will lead to a surge of increased spending and economic stimulus.

Tax expert Joel Slemrod, professor of business economics and public policy and director of the Office of Tax Policy Research, believes economic conditions are not much different now than they were in 2001 when President George W. Bush's 10-year tax-cut bill resulted in immediate rebate checks for many Americans. The bill was designed to encourage increased consumer spending and provide a short-run stimulus 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 says. "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 Many feel uncertain about whether the tax cuts will remain in place or be withdrawn in just a few years when conditions change."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 rebates, 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.

The problem is that the approach is not without costs, Slemrod says. "If you cut taxes without cutting spending, the government eventually has to raise taxes later."

Studies conducted in 2001 and 2002 by Slemrod and U-M economist Matthew Shapiro found that fewer than expected households said the tax rebate would lead them to increase their spending. By comparison, a 1992 change in standard income tax withholding amounts revealed a 43 percent spend rate. However, in 2001, only 22 percent of those surveyed said they would boost spending as a result of the 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.

They plan to conduct another study, due out this fall, to examine consumer response to the first two of this year's three tax breaks.

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