The Rate Reduction Tax Credit -- "The Tax Rebate" -- in the Economic Growth and Tax Relief Reconciliation Act of 2001: A Brief Explanation
The Rate Reduction Tax Credit — “The Tax
Rebate” — in the Economic Growth and Tax
Relief Reconciliation Act of 2001:
A Brief Explanation
Specialist in Public Finance
Government and Finance Division
The Economic Growth and Tax Relief Reconciliation Act of 2001 (P.L. 107-16)
created a rate reduction tax credit (RRTC) for tax year 2001. The RRTC was structured
to mimic a 10% income tax bracket. The tax relief provided by this credit was
transmitted to taxpayers via an advance check that was mailed to taxpayers in 2001.
These advance checks were based on information from income tax returns filed for tax
year 2000. The advance checks were not a rebate of taxes paid in tax year 2000.
Congress adopted the RRTC and the advance check transmission mechanism to
circumvent the problems associated with trying to provide immediate tax relief through
income tax withholding. Congress later clarified how the RRTC would interact with
the child tax credit and how dependents and nonresident aliens would be affected. The
IRS reported that through mid-February 2002, more than 1 million returns had RRTC
Economic analysis of the rebates generally concludes that households spent
between 20% and 40% of the rebate checks soon after receipt. The magnitude of the
RRTC impact on the economy in 2001, however, is uncertain.
This report will not be updated.
The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA, P.L.
107-16) generated considerable interest in the popular press. One provision that received
prominent coverage was the so-called “tax rebate.” In fact, the new tax law did not
provide for a tax rebate, rather; it created a “rate reduction tax credit” (RRTC) in lieu of
a 10% tax bracket for tax year 2001 for most taxpayers. Most taxpayers received the
RRTC in the form of an advance check from the IRS. The advance checks, which were
distributed between July and October 2001, were based on information contained in
taxpayers’ 2000 tax returns.
The complexity of the RRTC and the advance check for the RRTC led to much
uncertainty. In the fall of 2001, the Treasury Department asked for and received guidance
from Congress concerning how the RRTC should be calculated in light of new rules for
the chid tax credit. Also, at the request of the Treasury Department, the Chairman of the
House Ways and Means Committee and the Chairman and Ranking Member of the
Senate Finance Committee stated by letter their understanding that Congress had intended
to allow dependent filers and nonresident aliens to be eligible for a 10% tax rate bracket
in 2001, in lieu of the RRTC. The 2001 Act excluded dependents and non-resident aliens
from coverage under the provisions of the RRTC. But, it was less certain whether or not
they were eligible for the 10% bracket. The Treasury Department designed the 2001 tax
forms in a manner that is consistent with the letter it had requested from the leaders of the
congressional tax writing committees.
As formulated, the provision accomplished the objective of providing immediate tax
relief, but the complexity and uncertainty regarding the advance checks and the RRTC led
to numerous errors in the filing of 2001 federal income tax returns. The IRS reported that
more than 1 million returns filed through mid-February 2002 had incorrectly reported the
RRTC on their tax forms.1
This report explains the advance checks, the RRTC, the post-EGTRRA changes
affecting the RRTC, and why the RRTC was implemented instead of a retroactive 10%
rate bracket for 2001.
Explanation of the RRTC, Advance Checks, and 10% Tax Bracket
!The Economic Growth and Tax Relief Reconciliation Act of 2001
created a new 10% marginal income tax bracket for the first $12,000 of
taxable income for joint returns ($6,000 for single individuals and
$10,000 for heads of households). This new tax bracket is applicable for
tax years beginning in 2002.
!For 2001, the act created a rate reduction tax credit (RRTC) in lieu of the
!The RRTC for 2001 is 5% of the income that would have been subject
to the new 10% marginal income tax bracket. Hence, the maximum
amount of the rate reduction tax credit was $600 (5% of $12,000) for
married couples filing jointly, $500 for heads of households (5% of
$10,000), and $300 for singles (5% of $6,000).
!EGTRRA excluded dependents and nonresident aliens from eligibility for
the RRTC, but left unclear whether they would be eligible for the 10%
tax bracket for 2001.
1 See the following: [http://www.irs.ustreas.gov/pub/irs-news/ir-02-19.pdf]
!EGTRRA also implied that the RRTC should be applied after all non-
refundable personal tax credits. However, because EGTRRA also
changed the refundability of the child tax credit, it was unclear whether
the RRTC would be subtracted from tax liability before or after the child
!EGTRRA explicitly stated that the RRTC could be credited against the
alternative minimum tax (AMT).
!The RRTC was advanced to most taxpayers in the form of a check (the
“advance check”) from the U.S. Treasury Department in 2001. These
advance checks were distributed primarily between July and October
!The advance check was calculated based on a taxpayer’s 2000 tax
information. Taxpayers who had no tax liability in 2000, along with
dependents and nonresident aliens, were not issued an advance check.
!The advance checks were not rebates for taxes paid in 2000. The
advance checks were credits against 2001 income tax liability paid before
taxpayers filed 2001 tax returns. However, taxpayers were not required
to repay excess credits.
!The advance checks were issued based on the last two digits of the
taxpayer identification number (the taxpayer’s Social Security number).
The advance checks were issued beginning with the lowest last two digits
of the taxpayer identification number.
!Taxpayers who received the maximum advance check for their filing
status ($600 for joint returns, $500 for head of household returns, and
$300 for single returns) did not have to reconcile their advance check
with their RRTC when they filed their 2001 tax return.
!Taxpayers who did not receive an advance check or received an advance
check that was less than the maximum RRTC for their filing status, were
required to reconcile their advance check with their RRTC when filing
2001 taxes. After reconciliation, taxpayers that should have received a
RRTC greater than the advance check, claimed the difference as a credit
on their 2001 tax return. Again, taxpayers were not required to repay the
Treasury if the advance check was greater than the RRTC to which they
Clarification of the RRTC for Certain Groups
In a September 2001 statement released by the Senate Finance Committee,
Representative William M. Thomas and Senator Charles Grassley noted that “[d]uring the
drafting of the new tax forms, Treasury and Senate Finance Committee staff discovered
that the statute could be interpreted in a manner not consistent with Congressional intent.”
Therefore, the Treasury Department sought clarification of congressional intent regarding
how the RRTC should be applied to dependents and non-resident aliens. The Treasury
Department also sought clarification on the calculation of the RRTC in relation to the
child tax credit, because the child tax credit for families with two or fewer children was
changed to a refundable credit by EGTRRA.2
In response to the Treasury Department request, Representative William M. Thomas,
Senator Charles Grassley, and Senator Max Baucus sent a letter dated September 14,
2001, to Assistant Secretary of the Treasury for Tax Policy Mark Weinberger that
clarified their understanding of the intent of Congress concerning the issues the
Department had raised. In designing the 2001 tax forms, the Treasury Department
interpreted the statute in a manner consistent with the congressional intent expressed in
the letter of September 14, 2001. As a result:
!dependents and non-resident aliens who were not eligible for the RRTC
(and the advance checks) would, instead, be eligible for the 10% tax
bracket when they filed their tax returns for 2001;
!taxpayers who were entitled to claim child tax credits in 2001 were given
the maximum benefits of the refundable features of the child tax credit.
Thus, the child tax credit would be subtracted from a taxpayer’s income
tax liability after the RRTC had been subtracted;
!the RRTC is taken into account before the application of nonrefundable
personal tax credits that provide for a carryforward of benefits (the
adoption tax credit). Thus, the adoption tax credit would be subtracted
from a taxpayer’s income tax after the RRTC had been subtracted.
Why a RRTC Instead of a Retroactive 10% Tax Bracket?
Both the House and Senate versions of the tax cut legislation sent to the conference
committee included a new 10% tax bracket. The House version phased in reductions in
tax brackets, with the 10% tax bracket becoming fully phased in by 2006. The Senate
version established the 10% bracket retroactive to the 2001 tax year. The conference
agreement established a 10% tax bracket effective for tax years beginning in 2002.
However, the conference agreement included the RRTC instead of a 10% tax bracket in
Proponents of the RRTC cited the need for immediate tax relief to stimulate the
economy. They argued that the retroactive 10% rate bracket would not have delivered
immediate tax relief as cleanly as the RRTC because of potential problems implementing
changes in the withholding schedules. Under a retroactive 10% tax bracket designed to
deliver immediate relief in 2001, the new withholding schedules would have to “under”
withhold the second half of the year at double the amount to compensate for the “over”
withholding the first half of the year. As a result, take-home pay would have appeared
misleadingly large in the second half of 2001. Then, in 2002, the withholding schedules
would revert to withholding schedules consistent for a complete year of income tax
2 For more information on the child tax credit, see CRS Report RS20988, The Child Tax Credit
After the Economic Growth and Tax Relief Reconciliation Act of 2001, by Gregg Esenwein.
withholding. As a result, withholding in 2002 would have increased. The increase in
withholding would have reduced take-home pay, and it would have appeared to taxpayers
that their taxes had increased relative to the accelerated rate of withholding during the last
half of 2001.
A second option, implementing changes in withholding schedules without
compensating for the over withholding in the first half of 2001, would have delivered
approximately half of the tax relief in 2001.
So, Congress adopted the RRTC, which was transmitted to most taxpayers via
advance checks issued beginning in July 2001 an continued through October of 2001.
The RRTC circumvented the problems associated with trying to provide immediate tax
relief through income tax withholding. However, according to the IRS, the new line on
tax forms made necessary by the relatively complex RRTC led to numerous taxpayer
Impact of the RRTC
After the RRTC checks were distributed, economists evaluated the effectiveness of
the RRTC in stimulating the economy. The challenge of such an evaluation is isolating
the effect of the RRTC from all of the other components of the stimulus package. In a
March 2003 paper, Shapiro and Slemrod (SS) surveyed households “to determine how the
receipt of the rebate checks would change behavior.” They found that “21.8% of those
receiving the rebate reported that it would lead them mostly to increase spending.”3 SS
report that 32.0% would save the rebate check and 46.2% would pay down debt. Both
actions would do little to stimulate the economy in the short run.4 Another key finding
in the SS paper is that “low-income households were not more likely to spend the rebate.”
More recently, in a paper published in December 2006, Johnson, Parker, and
Souleles (JPS), found that
households spent about 20% to 40% of the rebate checks on nondurable consumption
goods during the three-month period in which the rebates were received ... and
roughly two-thirds of their rebates cumulatively during the quarter of receipt and5
subsequent three-month period.
These findings seem to counter the findings of SS though JPS explains that both studies
discovered that most households did save the rebate check initially. JPS, however,
tracked the households over a longer period after the checks were mailed and found
consumption expenditures eventually did spike upward. JPS conlude that their findings
“imply that the rebates provided a substantial stimulus to the national economy in 2001,
3 Mathew D. Shapiro and Joel Slemrod, “Consumer Response to Tax Rebates,” American
Economic Review, vol. 93, no. 1 (Mar. 2003), p. 381.
4 Shapiro and Slemrod, Mar. 2003, p. 394.
5 David S. Johnson, Johnathan A. Parker, and Nicholas S. Souleles, “Household Expenditure and
the Income Tax Rebates of 2001,” American Economic Review, vol. 96, no. 5 (Dec. 2006), p.
helping end the recession.”6 But, JPS stopped short of indicating that one-time tax rebates
will always have the same stimulative effect.7
6 Johnson, Parker, and Souleles, Dec. 2003, p. 1606.
7 For more on the impact of the rebate checks, see U.S. Congressional Budget Office, Options for
Responding to Short-Term Weakness, Jan. 2008, pp. 9-11.