Here is why so much of the stimulus is tax cuts:

People will spend them, increasing demand, at least in the short term.  The cuts will help financially constrained people the most.  And those are the people who should be helped.

I am not sure what the long term effects are though.  The big question is the insurance benefits versus the ex-ante incentive effects.  While I think that the incentive effects are small now, I am not so sure the next time.  That’s the rub.

RESEARCH

“The Reaction of Consumer Spending and Debt to Tax Rebates — Evidence from Consumer Credit Data” (S. Agarwal, C. Liu and N. Souleles)

We use a new panel dataset of credit card accounts to analyze how consumers responded to the 2001 federal income tax rebates. We estimate the monthly response of credit card payments, spending, and debt, exploiting the unique, randomized timing of the rebate disbursement. We find that on average consumers initially saved some of the rebate, by increasing their credit card payments and thereby paying down debt. But soon afterwards spending increased, counter to the canonical Permanent-Income model. Consistent with liquidity constraints, spending rose most for consumers who were most likely to be initially constrained by their credit limits, whereas debt declined most (sosaving rose most) for unconstrained consumers. More generally, the results suggest that there can be important dynamics in consumers’ response to ‘lumpy’ increases in income like tax rebates, working in part through balance sheet (liquidity) mechanisms.

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