Troubled economy? Tax credits to the rescue.

As Americans file their taxes Wednesday, many are getting a financial boost from recent tax changes that give consumers money to pay debts and buy cars.

By , Staff writer

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    A woman receives help from an IRS employee in Boston in this 2005 file photo. With this year's tax deadline approaching, changes and larger-than-usual taxpayer refunds are providing a burst of money to the struggling US economy.
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Tax changes and larger-than-usual taxpayer refunds are providing a welcome burst of money to the struggling US economy as Wednesday's tax-filing deadline arrives.

The impact of this "tax stimulus" won’t by itself push consumers back into shopping malls. One key reason: In a tough economy, consumers are more apt to use extra cash to pay down old debts than to make new purchases.

But this stimulus is still important. As many as two-thirds of Americans will get a refund, with at least a portion of that money likely to end up in the marketplace.

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The tax changes are an early piece of a larger effort by federal policymakers to bring the recession to an end this year.

The impact flows through a variety of channels:

- Refunds to taxpayers are averaging about $2,700 – or $200 more than last year, the Internal Revenue Service (IRS) estimates. The IRS says that refunds will total $300 billion this season.

- Starting now, give or take a few weeks, the IRS will take a smaller bite out of millions of Americans' paychecks. This is the “make work pay” tax credit, and it is a central feature of the $787 billion stimulus act that President Obama signed in February.

- Other tax breaks from the stimulus act are nudging some Americans to buy houses, cars, college educations, or energy-saving home improvements. Homebuyers can claim a credit of up to $8,000 on their 2008 taxes even if the purchase is made this year.

- Many businesses that are struggling with losses this year have a new opportunity to get back tax money they paid to the IRS in the previous five years.

“We’re making an impact. We’re getting real money into people’s pocketbooks,” Doug Schulman, the nation’s commissioner of Internal Revenue, said in a speech this week.

He gave anecdotes of the impact the tax changes have already had – ranging from an Indiana family using tax credits to offset the rising cost of college tuition to two window manufacturers that have driven up demand for their windows by touting the tax credit for people who improve the energy efficiency of their homes. The result has been jobs for 300 unemployed workers in Minnesota and West Virginia.

All this doesn’t mean the economy is turning a corner toward recovery right away. The total Obama stimulus package – including spending measures as well as tax breaks – may not outweigh the negative forces weighing on consumers, such as lost housing wealth. Moreover, concern about rising layoffs continues to hold back the economy.

Yet the tax refunds this year “are pretty high,” says Roberton Williams, a senior fellow at the Tax Policy Center in Washington. And “more than two-thirds of people get a tax refund…. The real question is what people will do with it.”

In most years, a lot of that refund money gets spent. This time, 54 percent refund recipients say they’ll use the money to pay off credit cards or bills, according to an Associated Press-GfK poll released Monday. That compares with 35 percent who said that a year ago.

Many of those who plan to spend some of the money say they’ll use it for basics like food, not big-ticket purchases.

Still, history suggests that when people get more money, at least some of it goes toward consumer purchases. The AP poll found some signs that this tendency persists. About 11 percent of those receiving refunds said they would use them to go on vacation, up slightly from a year ago. And 5 percent plan to use it on a car purchase – again a rise from last year.

Carbuyers will get a further nudge from the stimulus, which includes a sales-tax deduction on vehicles.

The “make work pay” credit is the largest tax break in the stimulus program and one of the quickest to take effect. It could put $116 billion into consumer pockets – or about $400 per worker – this year and next, the nonpartisan Tax Policy Center estimates.

The other tax items within the stimulus law are smaller – totaling $170 billion over 10 years.

These are intended to counterbalance the impact of the recession, which includes families’ loss of wealth in the housing and stock markets. Economists at Goldman Sachs estimate that this negative “wealth shock" dampens spending, costing advanced economies about 1.7 percent of gross domestic product this year. In the US, that amounts to about $240 billion.

Against that backdrop, the tax stimulus will provide “some offset,” says Adam York, an economist at Wachovia Corp. in Charlotte, N.C. “We’ll take what we can get for the US consumer right now."

A key question is whether the various credits and refunds give a further nudge upward to confidence – helping to bring an end to the climate of economic fear that has weighed on both employers and consumers. Mr. York says the stimulus could help soften the depth of the recession.

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