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Tax rebates might not spur a rash of spending

Associated Press
Published February 7, 2008


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"Just Do It," one of Nike's ad slogans, might be something the government should use to encourage consumers to spend their expected tax rebates.

A large part of the economic stimulus plan's success will hinge on whether Americans go shopping with their newfound cash. Proponents say a surge in buying could kick start the economy from its dismal state.

But before anyone counts on that, consider why consumers may not blow those rebate checks: Their mounting debts and worries about their economic future may lead to more saving than spending.

It's a clear sign that times are tough when the government starts looking for ways to use fiscal stimulus to prop up the economy. While it's unclear if a recession is upon us, there is evidence that the collapse in the housing and mortgage markets has spilled over to the broader economy. Businesses have begun to clamp down on hiring and credit conditions have tightened.

The Federal Reserve has been trying to control the situation through monetary measures, including aggressively cutting the federal funds rate.

Now Washington's politicians are working on a stimulus plan that includes tax relief for businesses and consumers. The House has overwhelmingly passed a $146-billion aid package that includes rebates of $600 to $1,200 for most taxpayers. Congressional leaders have been aiming to send the measure to President Bush by Feb. 15, but that date is in question amid the wrangling in the Senate. Democrats and Republicans want to add expensive components to the stimulus package, which includes rebates of $500 for individuals and $1,000 for couples in the Senate's version.

The earliest the rebates are expected to reach consumers is late spring or early summer.

Tax rebates have been included in efforts to recharge the economy - in 1975, 2001 and 2003. But those lump-sum cash payments provided only a "modest stimulus to consumption," according to a study by the congressional Joint Committee on Taxation.

That view was echoed by a new paper from the Congressional Budget Office, which said "most studies of purely temporary, one-time changes in taxes have suggested that they have only a moderate effect on household consumption."

During the 2001 recession, one-time rebates were paid starting in the third quarter, and consumer spending rose at an 7 percent annualized rate in the fourth quarter. That failed to offset the downturn in business investment, and the economy only grew at a sluggish 1.6 percent annual rate in that quarter, according to the Heritage Foundation, a Washington think tank. By the first quarter of 2002, consumer spending slowed to a 1.4 percent growth rate, hardly enough to trigger faster economic growth.

At the same time, the personal savings rates as the rebates were given out jumped to 3.4 percent from an average of 1.2 percent in the prior quarter. Economists at Merrill Lynch characterized that as a "vivid sign that much of the rebates went into the mattress."

We could see a similar pattern today, especially given the budget pressures faced by consumers. Gasoline prices are double what they were in 2001, debt-to-income ratios are at 140 percent versus 100 percent back then and the savings rate has turned negative, according to Merrill Lynch.

Americans might not eagerly put their tax windfalls toward the kinds of purchases - buying new cars or appliances, sprucing up their wardrobes or taking big trips - that could really recharge the economy's engines.

[Last modified February 7, 2008, 01:23:48]


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