by Josef A

Created on: May 19, 2009   Last Updated: May 21, 2009

There is a lot of economics in this question. You could encounter the concept of Arthur Laffer who would tell you that you that the state can even increase its revenues by tax rebates, if they have been too high before. Whether we are in a situation where that works remains an open question. More straightforward is the idea that tax rebates increase disposable household income that can be consumed and lift the economy. This is the classic idea of Keynesian economic policies. And these days we all seem to be Keynesian.

If you go back in history when Keynes first introduced his ideas on how economies work, how we can actively influence, and almost steer them like a ship, you will find great enthusiasm. Did someone actually solve the riddle how the economy works? The answer seemed suddenly clear and quite easy to handle. To put it plain and simple: Governments need to spend more in bad times and save in good times. Today there is not much left of that enthusiasm and we are more puzzled than ever when it comes to dealing with our economies. So why does this lovely idea of Keynes not work, although it sounds so good and simple.

Let's go back to the question about the tax rebates as a stimulus. So the government hands out money and is banking that people spend it. The problem is that they might actually not spend it, at least not as much of it as the government hopes. This can be explained by expectations people have for the future state of the economy. If their expectations are driven by fear and the prospect of decreasing wages and wealth, they will simply save the money. That, of course, kills the stimulus effect.

Taking a closer look at the current situation the U.S. economy is in, this scenario appears quite likely. Americans have based their consumption on ever increasing asset prices on the real estate and stock markets. The savings rate has become virtually zero and even dropped into the negative. Now that those assets are falling in value, many households realize their overstretched finances and a majority will certainly increase savings to a normal level, which is around 10% of disposable income. So those tax rebates will go straight into savings accounts or paying back debts and not into the American malls. All they will do is increase public debt, and some even argue that this increases interest rates in the long run and damps economic growth. At best, tax rebates as a stimulus will be in vain. In the long run they might even delay the future recovery.

Learn more about this author, Josef A.
Click here to send this author comments or questions.