Order Code RS22790
January 22, 2008
Tax Cuts for Short-Run Economic Stimulus:
Recent Experiences
Jane G. Gravelle
Senior Specialist in Economic Policy
Government and Finance Division
Summary
Congress is considering a short-run fiscal stimulus package which may include tax
reductions. In recent years, three different types of short run fiscal stimulus measures
have been enacted: an individual income tax rebate in 2001, a temporary investment
incentive (bonus depreciation) in 2002, and dividend relief in 2003. Some analysis
suggests that the cash rebate was an effective stimulus, bonus depreciation had a
smaller effect, and, on theoretical grounds, dividend relief was unlikely to provide an
effective stimulus.
Congress is currently considering a short-run stimulus package which may include
tax reductions, such as an individual tax rebate or investment incentives. Several types
of tax cuts were partially or fully enacted for purposes of short run economic stimulus in
the recent past (2001-2003). These tax revisions were the first in some time that were
motivated, at least in part, by the need for expansionary fiscal policy. In the late 1990s,
the economy experienced a protracted period of significant growth, and, in the decade
prior to that most tax legislation addressed a need for deficit reduction (the objective of
most tax change between 1982 and 1997, as was the case in the 1990 and 1993 tax
changes) or a desire for structural change (in the 1986 and 1997 tax revisions).1

Very different types of stimulus provisions were enacted in the period 2001-2003:
the 2001 tax cut was aimed at individuals, but most of its provisions, especially the rate
cuts, which were phased in over a number of years, were not based on the recession that
was apparent in 2000 and that appeared in the spring of 2001. When concerns about the
1 A stimulus provision proposed in 1992 to provide a credit against payroll taxes was vetoed by
the President. During the 1960s and 1970s a variety of provisions was enacted that were
associated with economic stimulus, including investment credits, rate reductions, and tax rebates.
The Joint Tax Committee has released a document that reviews tax stimulus provisions from the
1960s forward. It also has a discussion of potential effects, although some of that discussion
relates to longer term effects rather than short term stimulus aimed at countering an economic
downturn. See Joint Committee on Taxation, Overview of Past Legislation Providing Fiscal
Stimulus and Issues in Designing and Delivering a Cash Rebate to Individuals, January 21, 2008.

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economy continued towards the end of 2001 and in 2002, the Congress enacted bonus
depreciation. And, in 2003, the tax provision advanced to stimulate the economy was a
reduction in dividend taxation.
This report discusses the rebate, bonus depreciation, and dividend relief as
mechanisms for stimulating the economy in the short run.
The 2001 Rebate
The 2001 tax cut was not primarily enacted because of concerns about a recession
and most of the provisions were phased in over a number of years. However, concerns
about a slowing economy did motivate the advance tax rebate provided in 2001. Because
the tax cut was enacted close to mid-year (in May) it was difficult to provide a tax cut for
2001 that could be reflected appropriately in withholding. By the time withholding
changes could be put into place, much of the year would have passed and either
withholding changes would be inadequate (deferring tax cuts until returns were filed the
following year), or if made larger to compensate for the partial year effect would have
resulted in a withholding increase for some taxpayers at the beginning of 2001. The rebate
proposal provided for the mailing out of checks to taxpayers in the fall of 2001 that were
advance reductions for the introduction of a 10% rate bracket for 2001. They were,
however, based on taxpayers’ 2000 tax returns and any excess credits did not have to be
repaid when returns for tax year 2001 were filed. (Taxpayers whose credits were smaller
than those allowed on 2001 returns, however, received additional relief when tax returns
were filed). The checks were mailed out between July and October.2
The rebate met some important standards for an effective tax cut stimulus.3 Unlike
many stimulus proposals in the past, particularly in the 1960s and 1970s, where the
stimulus occurred during the recovery rather than the recession phase (potentially adding
to inflationary pressures), its impact occurred during the recession.4 In addition, tax cuts
are most effective as a stimulus if they are spent, and the tax reductions affected lower and
moderate income taxpayers who have a high propensity to spend.
At the same time, there was some concern that lump sum payments might be spent
in the same fashions as a continued increase in income through tax reductions. There was
some evidence that temporary rebates in the past were not spent.5 It appears, however,
2 The details of the plan are discussed in CRS Report RS21171, The Rate Reduction Tax Credit
in the Economic Growth and Tax Relief Reconciliation Act of 2001: A Brief Explanation, by
Gregg Esenwein and Steve Maguire.
3 See CRS Report RS21126, Tax Cuts and Economic Stimulus: How Effective Are the
Alternatives?, by Jane G. Gravelle, for further discussion. See also Congressional Budget
Office, Options for Responding to Short-Term Economic Weakness, January 2008, pp. 4-9.
4 See Congressional Budget Office, Ibid., p. 7, for a discussion and references to evidence that
the fiscal stimulus packages in the 1960s and 1970s were not well-timed.
5 Ibid., p. 10.

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that most of the rebate was spent fairly quickly: at least 20% to 40% in the quarter
received and two-thirds by the end of the second quarter after receipt.6

The Joint Tax Committee study7 discusses some important administrative issues
surrounding a cash rebate. Since 2007 returns have not been filed, a flat rebate would be
most easily accomplished if it were based on 2006 returns.
The 2002 Bonus Depreciation
Following the September 11, 2001, attacks, concerns once more arose about the
economy. A tax package proposal that included a business tax cut in the form of
reduction in the corporate alternative minimum tax and an acceleration of rate reductions
failed to achieve passage in 2001. In 2002, a bill was adopted and the centerpiece, as far
as tax provisions were concerned, was a temporary, two-year, provision for bonus
depreciation. This provision, responding to a concern about lagging business investment,
allowed businesses to deduct 30% of the cost of most business equipment purchases when
incurred rather than depreciating them over several years (typically five to seven years).
Bonus depreciation was increased to 50% in 2003 and extended through 2004.
Among the business tax incentives, a temporary investment subsidy should have the
most “bang for the buck.”8 By directing the subsidy at investment, the stimulus does not
provide a windfall for existing capital. By making the provision temporary there is an
incentive to make investment now rather than later. Nevertheless, a study of the effect
of temporary expensing by Cohen and Cummins at the Federal Reserve Board found little
evidence that bonus depreciation was effective in stimulating investment.9 They suggest
several potential reasons for a small effect. One possibility is that firms without taxable
income could not benefit from the timing advantage. In a Treasury study, Knittel
confirmed that firms did not elect bonus depreciation for about 40% of eligible
investment, and speculated that the existence of losses and loss carry-overs may have
made the investment subsidy ineffective for many firms, although there were clearly some
firms that were profitable that did not use the provision.10 Cohen and Cummins also
suggested that the incentive effect was quite small (largely because depreciation already
6 See David Johnson, Jonathan Parker, and Nicholas S. Souleles, “Household Expenditures and
the Income Tax Rebates of 2001,” American Economic Review, vol. 96, no. 5 (December 2006),
pp. 1589-1610.
7 Joint Committee on Taxation, Overview of Past Legislation Providing Fiscal Stimulus and
Issues in Designing and Delivering a Cash Rebate to Individuals.
8 These issues are discussed in more detail in CRS Report RL31134 , Using Business Tax Cuts
to Stimulate the Economy, by Jane G. Gravelle.
9 Darryl Cohen and Jason Cummins, A Retrospective Evaluation of the Effects of Temporary
Partial Expensing, Finance and Economics Discussion Series 2006-19, Federal Reserve Board,
Washington, D.C. April 2006. They compared investment increases for shorter lived and longer
lived assets (longer lived assets received a larger incentive) and investment closer to expiration
to test the effects.
10 Matthew Knittel, Corporate Response to Bonus Depreciation: Bonus Depreciation for Tax
Years 2002-2004, U.S. Dept. of Treasury, Office of Tax Analysis Working Paper 98, May 2007.

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occurs relatively quickly for most equipment), reducing the user cost of capital by only
about 3%, that planning periods may be too long to adjust investment across time, and
that adjustment costs outweighed the effect of bonus depreciation. Knittel also suggests
that firms may have found the provision costly to comply with, particularly because most
states did not allow bonus depreciation.
A study by House and Shapiro found a more pronounced response to bonus
depreciation, given the magnitude of the incentive, but found the overall effect on the
economy was small, which in part is due to the limited category of investment affected
and the small size of the incentive.11 Their differences with the Cohen and Cummins
study reflect in part uncertainties about when expectations are formed and when the
incentive effects occur.
One issue that these studies do not provide insight to is the desirable length of time
to allow the temporary provision. If the time is too long, the provision is not very
effective because the stimulus may be delayed, but if it is too short firms do not have time
to make adjustments.
Cohen and Cummins also report the results of several surveys of firms, where from
2/3 to over 90% of respondents indicated bonus depreciation had no effect on the timing
of investment spending.
Overall, bonus depreciation did not appear to be very effective in providing short-
term economic stimulus. It is possible, however, that a stimulus during current times,
when losses are not as large as they were in 2002-2004 when the economy was already
in a recession, could be more successful.

The 2003 Dividend Relief
The third provision that was advanced as a short term economic stimulus was an
Administration proposal to eliminate taxes on dividends in 2003. Eventually a proposal
that reduced the tax rates on dividends from ordinary rates to 15% was adopted as a
temporary measure; a reduction in the top capital gains tax rate from 20% to 15% was
also adopted.
While the provision was based on grounds of boosting the stock market and
stimulating the economy, this provision would not, on theoretical grounds, be considered
an effective short term stimulus. A short run stimulus must increase spending if it is to
be effective, and, for a tax reduction, that increase must be either in consumption or
investment. However, dividend tax relief is not likely to increase consumption spending
because it tends to accrue to higher income individuals who are likely to save it. It is not
an effective investment incentive because it benefits savers, not those directly making
11 Christopher House and Matthew Shapiro, Temporary Investment Tax Incentives: Theory With
Evidence from Bonus Depreciation, National Bureau of Economic Research Working Paper
12514, Cambridge, MA., September 2006.

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investments, and the translation from saving to investment would actually be
contractionary in the short term. Thus, although the provision was advanced as a short
term stimulus provision it is unlikely to be as effective for this purpose as other
alternatives,12 and the Congressional Budget Office study does not discuss it.13

12 For a more complete discussion, see CRS Report Rl31824, Dividend Tax Relief: Effects on
Economic Recovery, Long Term Growth, and the Stock Market, by Jane G. Gravelle.
13 Congressional Budget Office, Options for Responding to Short-Term Economic Weakness.