Do tax breaks help the economy?

Not demonstrably.

That is a complicated question. The simple, but unsatisfying, answer is, “sometimes.”

Basic economic theory says that when a free market is in equilibrium, that is, when the market is supplying the exact amount of a good that is demanded, then introducing a tax into that market will distort it and mean less overall economic output. The difference is called “deadweight loss.” Therefore, in general, reducing taxes on goods and services can, in cases where the market would otherwise function properly, help the economy.

BUT…economic theory also tells us that there are such things as “market failures.” These are situations in which the market does not function properly and there are many reasons why this can occur. In the cases of market failures, imposing a tax can actually fix the problem, bring the market into equilibrium, thereby improving overall economic output.

There is one other factor to consider (I’ll apologize here for the long post)...what do we do with the revenues that taxes raise? If those revenues are “invested” in programs and projects that improve efficiency and productivity, or reduce societal ills that tamp down economic output (such as crime, illiteracy, disease, etc), then tax revenue can serve as an important part of a long-term growth strategy.

I suspect that you wanted some take on the current situation and whether cutting taxes would help right now. Again, the answer is, “it depends.” Will it help to cut the top income tax bracket from 35% to 30%? No, probably not. That kind of tax cut will put more money into the hands of consumers who are likely to save at least a portion of that tax cut. Savings, in general, are not stimulative. However, cutting taxes for low-income workers could provide an immediate boost, as those folks are much more likely to go out and spend those dollars right away.

I am having trouble finding the reference, but the breakdown on the last one showed that the largest percentages went to savings and paying down debt neither of which stimulates the economy.

@Marina I guess you’re referring to the stimulus package that was passed in early 2008, which included $600 rebates. You’re not wrong, but there’s another piece to that story. Those rebates went to all taxpayers, including high and moderate-income households. Those folks did, generally, use that money to pay down debt (mostly credit card debt), and/or save. But there is good evidence that at the lower end of the income spectrum, that money was spent and flowed back into the economy. So while the 2008 rebate was not well targeted, it doesn’t undermine the basic idea that tax cuts can, sometimes, be stimulative.

It’s worth mentioning, as an aside, that many economists do argue that tax cuts are poor tools for economic stimulus compared to increased direct government spending. When the government spends money building a bridge, or upgrading a school, or boosting the staff at a neighborhood health clinic, those all create jobs, in the short run.

@Michael Yes, I was. Thanks for the additional information. I agree completely with your second paragraph.

Leaders tend to seize on single-front responses to poor effect (witness the fed and interest rate cuts as the be all and end all of economic fixes) when a broader quiver of tools and multi-front responses would be more effective.

You guys are way beyond me as usual but I did read something the other day (only, who knows where?) about an Obama tax cut that was designed differently from the Bush tax cut, and held out a bit more promise.
This version didn’t give people a lump sum but instead handed out, say, $40/month. Most people don’t bother to pay down debt at such a slow rate. They go out for dinner, they celebrate, they buy a shirt or a toy. It made a simple kind of sense to me. What do you think?

@susanc I had not read that, but I think it might, indeed, be more effective. Also, nice to meet you again in the Fluther stacks. I hope you are doing well.

If you really want to know, read this

But since it’s 68 pages of deeply complex economics, in case you don’t want to read it, look here and here for a more down to earth explanation of this paottom line though, cutting tax will result in less return on investment than would spending.

Thanks for the answers guys. I understand both sides and the middle a lot better now.

@Michael: A correction; those checks did not go to ALL taxpayers. As I understood people got payments of up to $600 ($1,200 for married couples) plus additional payments of $300 for each qualifying child. The stimulus payments phased out for those with adjusted gross incomes of $75,000 or more, and at $150,000 or more for married couples filing jointly.

@bythebay You’re absolutely right.

Only if the people receiving the breaks actually SPEND the money.

The tax cuts in the stimulus package are very specific and different than the tax cuts from the last eight years. There is a middle class tax cut of $500/$1000 but there is an income cap. There is a higher earned income credit that only affects low income worhers and there is a higher childcare credit. All of this makes it a little easier to some higher costs due to inflation and the reduction of suppliers. This is meant to be short term until the economy stabilizes.

The reduction in business taxes also makes good sense. The tax cuts are limited to small business who are being swept up in an out of control economy and are facing losses in a situation they did not contribute to. Small business will be allowed to write off more expenses in the next 2 years. And excess losses can be written off against past and future profits. What that means is for 2009 and 2010 a couple of bad years won’t put the small businessman. If he made a profit in 2008 and paid a tax on that profit, he can recoup that tax on a bad 2009 loss. If that is not enough he can recoup future taxes on this years loss.

None of this goes to the ‘bailout’ corps or upper income taxpayers.

Stimulus 101— CNNMoney.com

A very good primer on the plan under consideration with pros and cons

One small correction to galileogirl: the current stimulus plans under consideration by the House and Senate do not include a higher childcare credit. They include a more progressive version of the Child Tax Credit (CTC), which is different from the Child and Dependent Care Tax Credit (commonly called the child care credit).

If we (as in the national we) were serious about attracting and keeping good teachers in our schools, we would give teachers a graduated tax break. Every time we give teachers a raise, we take the money away from them with increased health care fees, as well as making them buy more needed teaching aids with their own money.
pet peeve

There is a small stimulus when taxes are really high then reduced. That trick only works a couple of times. There is a limit and that has long ago been reached. What the economy is an increase in demand. Only the government is in the position to increase demand by employing people. We need infrastructure repairs, transportation expansion, and energy efficient changes. Only the government can start these projects. Without this stimulus we are in for at least another 10 years of depression.