Personal Finance

Tax Cut Deal: Bad for Economy. Good for Credit.

December 10, 2010 by Christopher Maag 0 Comments

As the Obama administration and House Republicans try to pass a compromise tax cut deal over the objection of Congressional Democrats, perhaps they should read a new study co-authored by the Federal Reserve with some surprising findings: Tax cuts don’t actually boost the economy through higher consumer spending.

Instead, most people will probably use them to pay down debt.

More than half of consumers surveyed – 54% – said in 2009 that they planned to use money from tax cuts to pay down their debts, according to the study by economists Joel Slemrod, Matthew D. Shaprio and Claudia Sahm, an analyst with the Fed.

Only 13% said they will actually use the tax cuts to do what House Republicans and the Obama administration want them to do: Buy stuff and boost the economy. The results closely mirror those from a similar study Slemrod and Shapiro conducted in 2008.

With a compromise on the table to extend those tax cuts, researchers doubt that consumers’ behavior will change much.

“I imagine people have made some impact on getting their cushion back to where they want it to be,” thanks to using past tax cuts to pay down debts, says Dr. Slemrod, an economist at the University of Michigan. “So we’re not where we were a year ago, but we’re not out of the woods.”

The findings should come as no surprise. Ever since 2001, when Slemrod and fellow University of Michigan economist Matthew D. Shaprio conducted a survey on how people planned to use the money they receive from federal tax cuts, the results have remained pretty much unchanged.

Back then, only 22% of survey respondents said they planned to spend their tax cuts to buy things. “This propensity to spend is remarkably low,” the researchers wrote. In contrast, 59% said they would use the money to pay off debt.

Of course, people don’t always do what they say they will. So in 2009, Slemrod and Shapiro called the people they polled in 2008 and asked them if they followed through on their plans to pay down debt. Most people followed through on their plans, Slemrod says.

Image: Alan Cleaver, via Flickr.com