How tax relief can stimulate economic growth

The US Congress is debating an economic stimulus package that would substantially increase federal spending, but may not speed recovery from the current recession. The Congressional Budget Office estimates that less than 40 per cent of the proposed infrastructure spending in the stimulus bill will be spent within two years. Tax cuts, by contrast, can have an immediate effect, says Allison Hughey, a research assistant at the National Center for Policy Analysis.

A recent study by Christina D. Romer, one of President Obama's top economic advisers, found that a dollar of tax cuts raises gross domestic product (GDP) by about $3, more than twice the effect of a dollar increase in government spending. Therefore, Congress should consider some better, bolder tax-cutting ideas to speed economic recovery, says Hughey.

Cut Payroll Tax Rates:

  • For about the cost of the $825 billion House version of the stimulus bill, payroll taxes for Social Security could be cut in half, says former Federal Reserve Board member Lawrence B. Lindsey.

  • A 3 percentage-point reduction in payroll taxes would increase workers' take home pay an average of $1,500.

  • Reducing the employer's tax share by 3 percentage points would increase businesses' cash flow an average of $1,500 per worker.

  • This tax cut would reduce unemployment by lowering labour costs.

    Cut Corporate Tax Rates:

  • Cutting taxes on future profits is much more likely to spur new investment.

  • Congressional Republicans propose a step in the right direction: reducing the corporate income tax rate from 35 per cent to 25 per cent – the average rate in the European Union.

  • This would encourage businesses to hire additional workers, accelerate investment and make American companies more competitive internationally.

    Cut Capital Gains Tax Rates:

  • Republicans have also proposed reducing the capital gains tax levied on the increased value of an asset, such as stock or real estate, when it is sold.

  • The current 15 per cent rate is scheduled to rise to 20 per cent as the Bush tax cuts expire.

  • Making the lower rate permanent would be helpful.

  • Past capital gains tax cuts have yielded an immediate increase in government revenue.

    Source: Allison Hughey, How Tax Relief Can Stimulate Economic Growth, National Center for Policy Analysis, Brief Analysis No. , February 10, 2009.

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    For more on Taxes:

    FMF Policy Bulletin/ 24 February 2009
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