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BPEA Article

Is a Tax Rebate an Effective Tool for Stabilization Policy?

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Abstract

IN THE COURSE of the last decade, temporary changes in federal income tax liabilities have become a major tool of macroeconomic policy. The chief episodes so far have been the temporary surcharge of 1968-70 and the tax rebate of 1975. Another rebate was proposed by the Carter administration in early 1977 but was subsequently withdrawn. There has been a lively debate and wide disagreement in the economics profession about the efficacy of short-run changes in personal taxes as a device to stimulate aggregate demand and output. Transitory tax changes are advocated on the grounds that they can provide a prompt and temporary stimulus or restraint to the economy when it is needed and when permanent or longer-acting changes are not desirable because the structure of tax rates is deemed appropriate for the longer run. For a transitory tax change such as an income-tax rebate to accomplish its purpose, it should produce a large response in consumption per dollar of tax revenue lost by the government, and this response should be concentrated in a short time span following the tax reduction.

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