An Early Christmas Present
Subject Tax rebate
Topic Aggregate Demand/Aggregate Supply
Key Words Recession, Economic Growth
News Story

Approximately $38 billion in tax rebate checks are due to be delivered to taxpayers starting this summer. In addition, taxpayers will gain another $7 billion in reduced withholding. The $45 billion total rebate combined with at least five interest rate cuts, the tax cuts should stimulate consumer spending and help sustain the longest economic expansion on record. The first part of an 11-year reduction of $1.3 trillion will come in the form of rebate checks - up to $300 for a single taxpayer and $600 for a couple filing a joint return. If taxpayers follow historical patterns, they will immediately spend about a third of the $38 billion that they received in the rebate checks, providing a slight stimulus to the economy.

Consumers will use the rebate checks to reduce debt, for additional spending, or to increase savings. According to two surveys taken earlier this year, more than 60 percent of those surveyed said they would save most of a rebate or pay debts with it. Only about a third said they would spend the money on new purchases. In 1975, a similar government rebate resulted in consumers spending 25 to 40 percent of the money, with the remainder going largely into savings. In addition to the rebates, the tax cut will lessen withholding to the tune of $7 billion. In contrast to the rebate, past experience has shown that lowered withholding results in a higher percentage of additional spending. President Reagan's tax cut in the early 1980s resulted in consumers spending about 90 percent of the lowered withholding.

Some economists believe that unlike in the past, most of the tax rebate money will be spent on additional purchases. They argue that most of the rebate money will go to households with incomes of $50,000 or less, households with virtually no savings and a high propensity to spend.

Analysts believe that the cumulative effect of the additional purchases that result from the tax rebates and lowered withholding will cause the economy to grow by an additional one-half percentage point in the third and fourth quarters of this year. The tax cuts are part of an aggressive government effort to speed up an economic recovery.

(Updated July 1, 2001)

1. What are the primary determinants of aggregate demand?
2. Describe how a tax rebate and a reduction in withholding might affect each of the components of aggregate demand.
3. Describe how interest rate cuts might affect each of the components of aggregate demand.
4. Is a tax cut an effective anti-recessionary tool? Evaluate the argument made by some economists that the tax cut is bound to be implemented too late to counter the economic slowdown.
Source David Leonhardt, "Putting a Tax Rebate to Use," The New York Times, June 5, 2001.

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