The Bush Tax Cuts: Did they provide good "bang for the buck?"
The Bush tax cuts of 2001 to 2003 provided much less stimulus to the economy than other policies of equal cost would have. The underlying reason is that although the tax cuts were well-timed to provide a short-run economic stimulus, they were poorly designed for this task.
- The 2001 tax cut phased in reductions in marginal tax rates over a period of years, so that most of their impact came several years after their enactment. Such "backloading" reduces the ability of a tax cut to stimulate the economy in the immediate present. In fact, backloading can even reduce current economic activity, by encouraging people to postpone purchases or increases in work until after the full reduction in taxes has phased in. As the Wall Street Journal editorial board, a staunch advocate of tax cuts, has put it, "Delayed tax cuts are likely to depress the economy."
- The tax cuts provided larger percentage increases in after-tax income for higher-income households than for lower-income households. However, low-income households are more likely to spend any additional income they receive than higher-income households. Evidence from the 2001 tax cuts bears out this tendency. One study, using data from the Consumer Expenditure Survey, shows that households in their low-income category consumed 75 percent of their 2001 rebate, whereas the average household consumed 20 to 40 percent of its rebate. Thus the Bush tax cuts were not aimed at the segments of the population where they would have the greatest impact in stimulating additional purchases of goods and services.
- Many of the provisions of the 2001 and 2003 tax cuts-including the repeal of the estate tax and the expanded provisions for tax-free saving-were ostensibly designed to raise saving. Apart from the question of how effective these provisions were on that score, the appropriate strategy when one wants to provide a short-term stimulus to a weak economy is exactly the opposite: to raise spending, not saving.
- Even some of the provisions of the tax cuts that were ostensibly designed to raise consumption were inefficient ways of doing so. For example, one claim was that cuts in dividend taxes would boost the value of the stock market, raising wealth for many people and therefore raising consumption. But most people adjust their current consumption little in response to changes in the value of the stocks they own. One rough calculation suggests that when the value of stock holdings rises by one dollar, current consumption spending increases by just three to five cents.
- The 2002 tax cut allowed firms to count 30 percent of the value of new investment as an expense in the first year if made before September 11, 2004. These and other bonus depreciation provisions in the 2002 legislation were intended to encourage businesses to increase investment. Temporary investment incentives should indeed encourage a greater surge of investment in the near term, because firms have an incentive to take advantage of such provisions before they expire, and the bonus depreciation provisions were explicitly temporary at least partly for this reason. However, in 2003 Congress and the president extended the expiration date to the end of 2004 and expanded the first-year write-off to 50 percent. Meanwhile the Bush administration repeatedly insisted that the other tax cuts should eventually be made permanent. These actions, and perhaps the general sense that "temporary" tax cuts always get extended, may have led businesses to think that policymakers would continue to extend the bonus depreciation provisions and perhaps make them permanent. That would have undermined their ability to encourage investment in the short term. Indeed, a survey by the National Association of Business Economists released in January, 2004, found that 62 percent of respondents expected the provisions to be extended. (Interestingly, an even larger share, 73 percent, reported that bonus depreciation had no effect on their firm’s investment.) In the end, the provision was not extended when it expired at the end of 2004.