Rebates: an unexpected lift for weak economy

Tax cut could help economy turn corner from slump to growth near the year's end

Contrary to predictions just a few months ago, Congress has passed and President Bush has signed a major tax cut in time to stoke the nation's sputtering economy this year.

The tax cuts are still back-loaded, reaching their full impact some years down the road. But lawmakers made a concerted effort to reshape the package to offer some benefits immediately, especially to those in lower-income brackets who would be more likely to spend the cash.

Lawmakers also raced to complete their work: Mr. Bush signed the measure yesterday.

Now, economists say perhaps half of some $38 billion in tax rebate checks will be spent quickly, giving the economy a solid boost in the second half of this year.

"For once, Congress managed to implement a contra-cyclical fiscal policy that should boost economic growth exactly when the economy needs it," says Bruce Steinberg, chief economist of Merrill Lynch., a major brokerage firm based in New York

Single taxpayers will get checks of up to $300, while married couples filing jointly will reap up to $600. This reflects the creation by Congress of a new, 10 percent marginal income tax bracket for the first $6,000 of income ($12,000 for couples) retroactive to Jan. 1.

Single parents will get the 10 percent rate for up to $10,000 in income. Their maximum is $500.

That's real money for an economy that may be shrinking in the current quarter, which runs from from April to June.

Also, tax withholding rates drop 1 percent on July 1. That will provide taxpayers an extra $7 billion in the last half of the year.

The two measures combined should lift the growth rate for after-inflation gross national product to 3 percent in the second half, predicts David Wyss, chief economist at Standard & Poor's in New York. "If we're lucky, 3.5 percent."

Susan Hickok, chief economist at Prudential Economics in Newark, N.J., is even more optimistic: She sees a 4 percent growth rate by the fourth quarter.

By then, business will have worked off its excess inventories. The tax cut will account for 0.75 percentage points of that gain by lifting consumer demand. "When the economy pops, it is going to pop at a strong pace," she says.

Many Americans, when asked what they will do with the rebates to be mailed in August and September, talk about saving it. But economists say many will in fact rush to the store. And businesses will be making appeals to entice them to do just that.

"Not a bad idea at all," says Neal Cammarano, owner of Muzi Motors Inc., a Ford dealer in Needham, Mass.

Not all will get rebate

Still, some 34 million tax-return filers, 26 percent of the total, will get no rebate check at all, according to calculations by Citizens for Tax Justice (CTJ), a Washington advocacy group. This is because these taxpayers have such low incomes they pay no income tax. (They do pay Social Security and Medicare taxes.)

Another 17 million taxpayers, 13 percent, will get only partial rebates, says CTJ. On average, they will receive about half the maximums being talked about.

Also, about 2 million upper-income taxpayers will not benefit from the new 10 percent rate bracket because the so-called "alternative minimum tax" will take away any gain.

Moreover, eight states will in effect take some of the rebate money for their own treasuries. These states allow people to deduct federal tax payments from their state tax liability. So when the federal tax load goes down, the state tax burden goes up. The states are Iowa, Louisiana, Missouri, Montana, North Dakota, Oklahoma, Oregon, and Utah.

Nonetheless, most taxpayers will get a tax break of some size, with the largest dollar amounts going to the very rich.

Lawrence Kudlow, a New York economic consultant, argues that such a "supply-side" tax cut for the well-to-do will boost the trend rate for US economic growth to 3.9 percent a year during the second half of this decade from 3.5 percent now.

This view, on which many economists disagree, assumes that those getting the tax breaks will invest the money in making the economy more productive.

Impact on federal budget?

Whatever effects the tax cuts have on the near-term economy, one uncertainty is how they will impact federal revenues.

In the 1970s and 1980s, whenever the economy grew by 1 percent, federal revenues grew by about the same percentage. When tax rates on the wealthy were raised in the early 1990s, this ratio shifted. By 1994, 1 percent growth in GDP produced 1.4 percent more revenues.

The current measure's tax cuts for the rich could pull ratio down to 1 to 1.3, suspects Fred Ross, a consultant to the Schwab Washington Research Group.

Even with the tax cut, a budget surpluses will continue, but these are largely in the form of payroll taxes that go exclusively for Social Security and Medicare.

But outside the payroll-tax surpluses, Congress will have little extra revenue for additional defense spending or the coverage of drug costs under Medicare, or for other new goals. "For the next two, three, or four years, not much is left," Mr. Ross says.

Budget "hawks," who don't want Washington to have the revenues necessary for new programs, are delighted.

(c) Copyright 2001. The Christian Science Monitor

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