Tax rebates don’t always work

by on January 18, 2008 at 9:37 pm in Economics | Permalink

Matt Shapiro and Joel Slemrod report:

Many households received income tax rebates in 2001 of $300 or $600. These rebates represented advance payments of the tax cut from the new 10 percent tax bracket. Based on a survey of a representative sample of households, this paper finds that only 22 percent of households receiving the rebate would spent it. Instead, they would either save it or use it to pay off debt. This very low rate of spending represents a striking break with past behavior, which would have suggested a much higher rate of spending. The low spending rate implies that the tax rebate provided a very limited stimulus to aggregate demand.

The pointer is from Angus.  Purely coincidentally, a moment later I read the following:

…both the White House and Congressional Democrats are leaning heavily
toward a combination similar to the one the administration turned to in
2001 as a recession-fighting tool. It would include a one-time tax
rebate for individuals and an immediate expansion in the deductions
that businesses take for investment in equipment. If Congress acts
quickly, checks could be in the hands of American taxpayers as early as
spring.

Hmm….By the way, here is the Elmendorf and Furman paper on fiscal stimulus.

Addendum: Don’t forget Alex’s post on this.  Mark Thoma and Bruce Bartlett are here, and as you might expect Greg Mankiw asks the correct pointed question.

srp January 18, 2008 at 10:28 pm

Back in 1978, when I took macroeconomics as a freshman, Burt Malkiel explained that under the permanent income hypothesis temporary rebates would tend to be saved rather than spent. Apparently there was some evidence of that back when the Ford and Carter administrations deployed rebates. Of course, this was pitched in the context of the primitive Samuelsonian Keynesianism preached at the time, in which saving was always bad and spending always good and the economy never at full employment.

Ronald Brak January 19, 2008 at 3:40 am

Here money gets handed to people with children, with no need to worry about tax rebates. While effective
at getting money spent, rather than being only used as a carefully timed fiscal boost, it has unfortunately
become an election year staple.

odograph January 19, 2008 at 6:28 am

It occurred to me some time ago, that if consumers are in a debt crisis, and the government gives them stimulus, it is essentially a transfer of debt.

We move debt off our (collective) books and onto the Federal ledger.

meter January 19, 2008 at 7:51 am

Isn’t it the spending – at every level – consumer, business, government – that got us into this mess?

Diversity January 19, 2008 at 9:08 am

The presnt danger is that significant parts of the US economy will go into “balance sheet repair mode”. (Keynes would have recognised the phenomenon.) That can start a chain reaction forcing other economic actors into balance sheet repair.

Stimulus by Government spending cannot normally break that chain reaction in time because Governments are not prepared to spend a lot more money quickly (see Japanese experience). Oddly, the only department that is so geared is Defence. Extra spending on rebuilding arms and military supplies stocks – and other strategic stocks which impact on domestic demand – may be worth committing now if Congress lays down a short time limit in which the money must be spent. That apart, the best bet for fiscal stimulus is for the Government and Congress to follow Elmendorf and Furman’s advice, and do it yesterday.

The answer to Mankiw’s question is that if we are so desperate as to need the fiscal stimulus, we certainly need a temporary interest rate cut as well. In that short term, the usual trade off does not apply.

dWj January 19, 2008 at 12:17 pm

Spending at permanent income is subject to solvency constraints. The federal government faces fewer solvency constraints than many households, especially now.

As for Mankiw’s point, I believe fiscal and monetary stimulus operate with different lags, and — excluding the “political lag” involved in simply getting fiscal stimulus effected — that fiscal policy has a shorter lag than monetary policy. Does anyone here know anything more about that?

Arr-squared January 19, 2008 at 4:54 pm

“this paper finds that only 22 percent of households receiving the rebate would spent [sic] it. Instead, they would either save it or use it to pay off debt.”

IANAE, but it seems like considering paying off debt as closer to “saving” than “spending” seems to be off base. I don’t know how much paying down debt stimulates the economy, but it seems like debt payment should free up future income for spending.

aoc gold December 31, 2008 at 12:22 am

Please come to age of conan gold, we will give you a great surprise.

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