The $600 tax rebate most U.S. households received last year was exactly the right tool to help stimulate consumer spending and start the sluggish economy on the road to recovery, according to Larry Seidman, professor of economics and Chaplin Tyler Professor of Business. But, he says, the boost shouldn't stop there.

"Most economists agree that the government should not be curbing spending or reining in debt during a downturn," Seidman says. "Last June's $600 rebate was an inspiring, nonpartisan response, but it was just the first step toward recovery. What Congress should do now is triple last year's rebate, mailing $1,800 to every household."

Why is another tax rebate the right thing to do? For one thing, Seidman explains, the effects are immediate. "Congress passed last year's rebate in June, and by July the Treasury Department was mailing checks," he says. "Taxpayers had the money in their hands by the end of the summer. Other forms of government spending may not affect the economy widely enough or until it's too late for a quick recovery."

A tax rebate, which is implemented only as needed, also has the virtue of being temporary, Seidman says, "unlike a tax cut, which is extremely difficult to undo if the economy takes an upward turn."

He says he worries about the government's reliance on interest rate cuts by the Federal Reserve as the primary means of promoting economic growth. In a period of inflation, when interest rates are high, the Fed has room to maneuver, he says, but interest rates were cut in 2001 alone from 6.75 to 1.75 percent.

"The Federal Reserve is running out of ammunition," Seidman says. "Interest rates can't go below zero percent, and we can see from Japan's example that cutting rates that low doesn't necessarily pull the country out of recession. A better solution is to give a larger tax rebate to consumers at all income levels. If people spend more than we expect and the economy recovers so strongly that we begin to see inflation, the Fed can raise interest rates again to slow things down."

Seidman says research shows the value of tax rebates in spite of the fact that, so far, there is no conclusive evidence that taxpayers spent their 2001 rebate checks as Congress had hoped. In a survey taken last September by the University of Michigan, most respondents claimed to be using the rebate dollars to pay down debt or add to their savings, while only 20 percent said they planned to spend the money.

Noting that this figure is consistent with past experience, Seidman says that, in the year following a tax rebate, more than 50 percent of the money historically gets spent. If that holds true again, the 50 percent should give the economy a boost, he says.

"It's hard for many people to say exactly how they spent their rebate dollars, because they probably deposited the check in an account where it was mixed with other money," Seidman says. "And, of course, there is no way to know what people would have spent if they hadn't received the check. But, even if most people saved the 2001 rebate dollars, they will likely begin to spend more freely if a second check arrives."

Since the Great Depression of the 1930s, economists have generally agreed that when recession threatens, the government should stimulate household and business spending, even if doing so means running a budget deficit. Paying down the debt in better times, they say, is what budget surpluses are for.

"We need to make this kind of fiscal policy automatic, triggered by the state of the economy," Seidman says. "Ideally, Congress would enact a policy that provides rebates if economic output falls more than 2 percent below its normal growth. Then, if things do not improve within a certain amount of time or if the economy sinks lower, another, larger rebate is mailed, and the process continues until conditions improve."

Some economists have proposed setting up an independent advisory board similar to the Federal Reserve to handle such fiscal policy. Although Congress has been reluctant to empower such a group, Seidman says, "We need some type of program at least one step removed from politics that can act fast to fight recession."

Compelled by his strong feelings about this issue, Seidman has just completed a book with the working title Automatic Fiscal Policies to Combat Recessions. A related paper appeared recently in the economics journal Challenge, and his work was cited in the Jan. 19 issue of The Economist.

"I believe that economists--including professors of economy--are responsible to keep pushing both parties in our government for changes that we believe are in the economy's best interest, regardless of the political difficulties we encounter," he says. "I try to prod other economists to use the influence of their writings, and I meet with congressional staff who handle this type of legislation. My colleague Ken Lewis [Chaplin Tyler Professor of Business] and I have completed a technical paper using a macro-econometric model to see how an automatic rebate policy might help an economy in recession."

Seidman's broader interests in tax reform resulted in an earlier work on a proposed consumption tax. Although he wrote that proposal to encourage people to save more during good times, he also sees an interesting outcome for a recession.

"Cutting a consumption tax temporarily during a recession is even more effective than a tax rebate," he says. "It's not unlike a sale at a department store--consumers want to buy more because they know the price will soon go back up. If states were to cut sales taxes during 2002, for example, this could provide a significant stimulus. In fact, I believe that it is a good idea for the federal government to reimburse states that do temporarily suspend their sales tax."

The campaign for fiscal reform will be ongoing, even if the economy recovers, according to Seidman. "If we don't have a strong recovery, I think that the climate will be more receptive. If we are fortunate and do pull out, then the $600 rebate will deserve some of the credit," he says. "But, the next time we may not be so lucky. We will always have recessions, and some of them could be severe. That's why we need this policy. It's an insurance policy for the future."

--Mary Jane Pahls