Rebate Folly

I was exploring some old CBO reports for information on dynamic budget scoring and I came across this nugget:

If a tax cut—such as a rebate or a higher standard deduction—does not reduce the tax on income from an extra hour of work, the additional income will create an incentive for people to cut back their working hours and spend more time at home. Not everyone will respond, but some people (especially second workers in a family with one full-time earner) may decide to leave the labor force to care for children or aging parents or to pursue other interests.

(Supplement to CBO’s May 9, 2002, Testimony on Federal Budget Estimating May 2002 CONGRESSIONAL BUDGET OFFICE, page 9)

We are about to receive a rebate in May this year as part of the economic stimulus that Congress passed in February. I suppose the folks at the CBO would have pointed out that although a rebate may stimulate consumer spending, it is also likely to reduce labor supply. The net impact, therefore, would not necessarily involve any increase in national output but it would certainly induce stronger inflationary pressures—adding fuel to the inflationary fire the Fed’s apparently stoking by cutting interest rates so rapidly. So it’s perhaps not surprising that the dollar’s value took a nosedive during February this year.

Higher rebate-induced debt and higher inflation implies higher future interest rates and, therefore, increased cost of financing consumer and investment spending. Rebate recipients will benefit today, but everyone will lose in the long-term as the economy becomes more sluggish.

Bottom line: Politicians gain by appearing to be doing something – and most of us lose!