To Spend or not to Spend
Subject Lower Taxes
Topic Taxes, Spending, and Deficits
Key Words Tax Cuts, Tax-credit Checks, Consumer Spending, Consumer Savings, Business Investment, Interest Rates
News Story

President Bush, possibly recalling that his father's defeat in the 1992 election was at least partially caused by a weak economy, has pushed for and obtained a third round of tax cuts for the American consumer. Bush and his advisors have argued that the cuts will substantially improve the economy and lead to job creation. Congress passed the tax bill in May and the final round of tax-credit checks are reaching American consumers this week.

Democrats claim that the tax cuts will mainly benefit the wealthy and any new spending would be limited at best. Additionally, the democrats say the cuts have not improved the economy and in fact will simply increase the already record-breaking deficits.

The Federal Reserve, lead by Chairman Alan Greenspan, and many private economist expect the tax cuts and the record low short-term interest rates to stimulate the sagging economy. The tax cuts should stimulate consumer spending, and the low interest rates should motivate business to invest in new capital and equipment, which will lead to new job creation.

Daniel Howard, a consumer behavior specialists and chairman of the marketing department at Southern Methodist University Cox School of Business, suggests that most Americans are spenders as opposed to savers. They usually have a list of items they plan to purchase when funds are available. This suggests that when the rebate checks arrive, they will most likely be spent. Consumers were sampled and asked about what they would do with their refunds, most already had determined a product they were interested in purchasing. Jodi Fields, of Potomac, Md. had already identified a digital camera to buy with the $400 refund check. Luigi Esposito is buying a new boat, while Jack Manasco is saving for a rainy day.

If Professor Howard is correct in his prediction that most Americans are spenders, the tax cut will have a significant impact on the recovery. Lynn Reaser, chief economist at Bank of America Capital management agrees. She says, "We believe the $400 checks, in particular, are going to have a significant, positive effect on consumer spending." She also reported that retail sales have been improving of late, indicating that the checks are already showing an impact. Mark Zandi, chief economist at Economy.com, expects consumers to spend about half of their tax refunds. The other half would be saved, making funds available to businesses for capital expansion.

Some experts expect the tax cuts to boost economic growth by one-half of one percent in the second half of 2003. If so, this will improve growth to an annual rate of 3.3 percent as compared to only 1.9 percent in the first half of the year. This would be good news to the Bush administration as the election approaches.

(Updated September 10, 2003)


How are tax cuts evaluated and explained in the traditional Keynesian model?

2. Explain the multiplier effect of an increase in business investment caused by lower interest rates.
3. Why is savings necessary for the growth of the economy?
Source Associated Press, " Spending Critical to Economic Recovery," Florida Today, August 18, 2003.

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