Wednesday, September 14, 2011

Who spent the 2001 Bush tax rebate?

Do tax rebate such as those implemented at various times by the Bush II administration work? Measuring this is not obvious. Previous studies have typically exploited the timing of the receipt of the rebate checks to see how expenses have changed. But most people have anticipated these payments, thus the marginal propensity to consume is mismeasured: it measures the propensity to consume due to short-term liquidity considerations beyond the consumption response from the announcement of the program.

Greg Kaplan and Giovanni Violante go a step further in this analysis and build a model that replicates the measurements found in the literature and the large share of hand-to-mouth households using an economy of liquid and illiquid assets with transaction costs. They define hand-to-mouth households as those who hold less that half their periodic pay in liquid assets. That seems very shaky to measure, as the timing of the relevant survey matters a lot here. But assuming there is no systematic error, they then extrapolate through the model what the response from the announcement of the rebate should have been. This adds 7-8% to the marginal propensity to consume. Interestingly, this come in large part form rich household who have only little liquid wealth because their assets are mostly in real estate and retirements funds. An important consequence of this is that larger tax rebates would have little impact, as they would make it more interesting to bear the costs of putting them into illiquid wealth. In fact, the marginal propensity to consume could even turn negative.

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