MIT experts on economics, public opinion and international financial regulation are optimistic that this year's tax rebate plan will briefly stimulate the U.S. economy, but they warn that rebate checks alone won't sustain economic progress in the face of record-high consumer debt.
Thirty-four million U.S. taxpayers are expected to receive rebate checks, ranging from $300 to $1,200, between early May and mid-July. The program will cost about $150 billion--a reasonable price to pay for a pretty sure thing, says James Poterba, economics department head and Mitsui Professor.
"Job One for the economic policy-makers is stimulating spending. As houses and other assets lose value, people defer purchases, and the economy slows down. Rebates inject money into the system. They're fast, but they're temporary. No one thinks they're a panacea for a long-lasting economic downturn," Poterba says.
Poterba bases his guarded optimism about the 2008 rebates on data collected on the 2001 tax rebates, which show that taxpayers spent about two-thirds of their rebates within six months of receiving checks.
The 2008 rebate program is aimed at low-income households, because these households are the least likely to save the rebates.
Economists who study human behavior note that the spending effects of the rebates may depend on their form.
Amy Finkelstein, associate professor of economics, has studied how the visibility of taxes affects the way taxpayers respond to them. She speculates that rebates that are received as electronic deposits may seem less like spendable cash, and more like potential savings, than checks that taxpayers receive in the mail.
"It's also possible that people who are liquidity constrained might spend the rebate more quickly," she says.
Dan Ariely, Alfred P. Sloan Professor of Behavioral Economics, takes the "how" of the rebates further. His research shows people value what they have, so he suggests a middle path to make sure the rebates are swiftly recycled in goods: Provide debit cards validated only for purchases instead of checks or electronic deposits. Such cards were used in the aftermath of the 2005 Gulf storms.
"I suspect that giving people a prepaid debit card will do more to rejuvenate the economy than mailing out checks, but direct deposits wouldn't be nearly as effective," Ariely said in a recent commentary for the Marketplace radio program. "I also suspect that if we added a line on the debit card that reads 'spend the government's money' this would work even better."
Tax rebates produced mixed economic results in summer 2001, but today's gnawing fiscal anxieties across income groups won't be calmed by rebates, according to David Andrew Singer, assistant professor of political science.
"Today's economy is not the same as the pre-Sept. 11 economy. Thousands of homeowners face foreclosure or financial distress as their mortgage interest payments head inexorably higher. Consumers will be much more conservative with their rebates this summer than they were seven years ago," says Singer, an expert on international financial regulation.
"If consumers save rather than spend the money, there will be no stimulus," he adds.
Andrea Campbell, associate professor of political science, is currently at work on a book about taxation and public opinion. She anticipates Americans' low savings will lead them to spend their rebate checks.
"Generally, two out of five adults confess on surveys to living paycheck-to-paycheck--probably an underestimate--and most Americans have surprisingly slim savings," Campbell says. "These facts suggest that ordinarily most people would spend their checks and therefore stimulate economic growth."
But Campbell joins her colleagues in speculating that indebtedness may blunt the effect of this round of rebates.
"People may feel chastened and therefore more likely to use their rebate checks to pay down debt than to spend. This would have a less stimulating effect," she says.
The tax rebate program is only a short-run modification of the U.S. tax code, not a fix for what ails the system, economists note.
Poterba, who served on the 2005 President's Advisory Panel on Federal Tax Reform, argues that there is also a strong case for more long-term changes in the way the federal government raises revenue. "The tax cuts of 2001 are due to expire in 2010. The new president and new Congress will have to revisit tax changes such as broadening the income tax base and revisiting big deductions," he says.
A version of this article appeared in MIT Tech Talk on April 9, 2008 (download PDF).