Benefits of tax rebate policy

Where the government decide to give $ 1,000 tax rebate to every family in America it has an effect of increasing the amount of money circulating in the economy i. e. it is a kind of expansionary fiscal policy. 1. Benefits of tax rebate policy to individual consumers A. increase in consumption – the tax rebate will increase the amount of disposable income held by the household. As disposable income increases then consumers will have available fund to spend on various consumption bundles. The consumption function is illustrated as;

C = a + cYd Where C = consumption a = autonomous level of consumption Yd = disposable income c = marginal propensity to consume c = ? C, 0<mpc<1 ?y Therefore as seen from illustrated by the equation consumption expenditure varies directly with the level of disposable income. Many consumers particularly the poor were forced to cut consumption on essential goods due to financial crisis and such a policy will act as a relief to many who will be able to resume their original consumption bundles.

2 B. increase in saving – the credit crunch and recession in the economy made it hard for household to obtain credit from financial institution therefore many resulted to withdrawing their saving to cater for domestic needs particularly those who lost their job. Where individuals receive an increase in income they have the option of increasing saving or consumption i. e. Yd = C + S. therefore the saving function can be derived from the equation above to get

S = Yd – (a + cYd). From the equation there is a direct relationship between increase in saving and disposable income therefore tax rebate will increase saving by individual household (mishkin, 2001). C. increase in value of property – tax rebate will increase the purchasing power of consumers and in a scenario where the economy experience an increase in money supply prices of assets such as shares and house tend to increase.

Therefore individual shareholders will benefit from capital gain in addition increase in house price will make it possible for home owners to re-mortgage i. e. taking additional loan based on the difference between the current value of the house and outstanding loan balance. Drawbacks – General increase in prices of good and services (inflation). Increase in disposable income causes aggregate demand to be greater than aggregate supply and in applying the law of demand where demand is high and supply is low price increases.

Therefore individual household will pay more for goods and services. Hence tax rebate will cause an increase in nominal income but real income may remain unchanged (white, 1994). 3 – Increased cost of borrowing – such an expansionary policy by government will cause interest rate to rise. Therefore individuals who seek fund from banks will now have to pay more in term of interest on loans and this make borrowing costly.

In addition individual servicing loans and mortgages may be required to make additional payment in term of interest (Beardshaw, 2001). – Loss to bond holders – interest rate has an inverse relationship with bond price. Therefore tax rebate causes an increase in money supply which in turn forces interest rate to rise. This will cause bond price to fall and investors who want to sell their investment may experience losses.