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Friday, February 1, 2013

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

Jane G. Gravelle
Senior Specialist in Economic Policy

Several types of tax cuts have been debated for fiscal stimulus bills in recent years, and a fiscal stimulus was adopted in February, 2008 (P.L. 110-185) and a much larger one in February 2009 (P.L. 111-5). Both included individual tax cuts aimed at lower- and middle-income individuals, along with business tax cuts. In December 2010, along with an extension of expiring tax cuts, a temporary payroll tax cut was adopted. Many, but not all, tax cuts that were expiring after 2012 were extended permanently. Further stimulus might be considered in the 113th Congress, if employment rates remain high.

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 weak evidence that tax cuts received in a lump sum will have a smaller stimulative effect than those reflected in paychecks, but this evidence is uncertain. However, studies of the 2001 rebate found that a significant amount of that rebate was spent. While temporary individual tax cuts likely have smaller effects than permanent ones, temporary cuts 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.) The effect of business tax cuts is uncertain, but likely small for tax cuts whose main effects are through cash flow.

Date of Report: January 18, 2013
Number of Pages: 8
Order Number: RS21126
Price: $19.95

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