The Congressional Budget Office (CBO) recently released a paper: Did the 2008 Tax Rebates Stimulate Short-term Growth?

The paper is a comprehensive summary of the best recent literature on the topic. CBO sorts the literature into three categories:

  • Studies that used detailed data about individual spending to study the effects of the temporary tax rebates;
  • Studies that used survey data of what individuals did with the money when they received it; and
  • Studies that used national data on income and spending to measure the effects of the tax rebates.

The CBO paper is a good summary about the effects temporary tax rebates have on consumption, and what does it conclude about this?

The CBO paper is a useful review of the relationship between temporary tax rebates and consumption, but the paper is ultimately misnamed. None of the literature in the three categories connects a rise in consumption to a resulting increase in economic growth, nor does the CBO paper explain the linkage between increased consumption and increased output.

For the title to be accurate, readers must assume that increased consumption inherently increases total demand and growth. However, by increasing consumption, tax rebates can only alter the composition of demand, not the level of demand. And without altering the incentives to produce, tax rebates cannot affect the level of production.

For tax cuts to stimulate economic growth, they must permanently improve the incentives to produce by reducing effective marginal tax rates:

Long-term tax rate reductions–as opposed to short-term jolts–are needed because the important economic decisions that will trigger a real recovery depend on more investment in new factories and new equipment. Americans are more likely to make these investments when they believe that there will be a long-term improvement in the after-tax returns to investing, working, and taking economic risks. Such improvement requires long-term marginal rate reductions, not a temporary shot-in-the-arm.

For this reason, a better title for the CBO study is: Did the 2008 Tax Rebates Stimulate Short-term Consumption Increases?