Historically, tax cuts have been used as legislative tools to stimulate economic activity.

By reducing the tax burden on individuals, families or companies, tax cuts increase the real income that is available to purchase goods and services. But at the same time, tax cuts decrease the government's real income, forcing legislators to either cut spending or sell additional bonds to finance the shortfall.

In the U.S., tax cuts are hotly debated topics. While some analysts insist that temporary tax cuts play a critical and beneficial role in encouraging additional spending and investment, others argue that many tax cuts are ineffective and ultimately result in reductions to programs that benefit citizens.

Types of Tax Cuts

In the U.S. tax system, several different types of tax cuts have been used to stimulate spending and investment among targeted groups of taxpayers:

  • Tax Rebates: Tax rebates are a type of tax cut in which taxpayers receive refunds on taxes they have already paid. For example, in response to the 2008 financial crisis, the Bush administration rolled out a tax cut in the form of a one-time tax rebate that was mailed to taxpayers.
  • Reduced Withholding: Instead of rebating taxes that have already been paid, a reduced withholding tax cut decreases the amount of taxes that are regularly held back from employee compensation. While this type of tax cut increases taxpayers' income more quickly, taxpayers' are less likely to notice it—a scenario that played out with the tax cuts that were part of the Obama administration's stimulus plan.
  • Business Tax Cuts: Business tax cuts reduce the tax paid on profits, with the hope that companies will reinvest profits in jobs, capital improvements or business expansion. Over the years, the U.S. government has offered various types of business tax cuts. For example, the 2003 Jobs and Growth Tax Relief Reconciliation Act (JGTRRA) increased tax deductions for small businesses and reduced tax rates on long-term capital gains and dividends.