Tax refunds and myopia

From anecdotal evidence, it appears that many Americans like to use the refund from their yearly tax filing for various home improvement projects. That seems like a strange habit, but could be explained by its timing (Spring season) and the unexpected nature of this windfall that is large enough to allow some major purchase that would not happen during the rest of the year. For perennially cash-constrained households, being forced to put a little aside for a one-time cash-out is the only way to do some capital purchase. Does this theory make any sense? It does in developing countries where ROSCAs are popular for this reason.

It looks like the same holds for US households. Brian Baugh, Itzhak Ben-David and Hoonsuk Park look at purchase patterns when the tax forms are filed and when the tax refund check arrives. The first finding is that consumption does not move at the filing, even though uncertainty about the refund resolves. In other words, a change in the permanent income here does not matter, presumably because there is some constraint. When the refund check is cashed, though, consumption jumps up and returns to the previous levels within weeks. It looks like households are cash-constrained. But the composition of the purchases indicates that there is a substantial amount of non-durables in the basket, showing also they are rather impatient. In fact very little remains for savings. I would have expected that at least credit card debt would be drawn down. One can thus conclude that their myopia dominates the cash constraint. Sad.

Are multipliers larger than we thought?

In the last years, much of the debate on fiscal stimulus vs. austerity was centered on the measurement of government spending multipliers. And to a large extend this was a debate between those how used dynamic stochastic general equilibrium (DSGE) models, finding small multipliers, and those using reduced form models, finding large multipliers. Both strategies have pitfalls, the structural one in that the model may be miss-specified as it is always an abstraction of a complex reality, the reduced-form one because of the Lucas Critique.

Patrick Fève, Julien Matheron and Jean-Guillaume Sahuc make the point that there could be a source of downward bias in the estimation of the elasticity in structural models. It arises from ignoring the endogeneity of government expenses combined with complementarity between public and private consumption. With exogenous expenses, the elasticity is 0.97 for the United States, with endogenous ones, it is 1.31. No small potatoes.

The deadweight loss of gift certificates

Giving gifts in kind induces large deadweight losses, as I discussed in one of my very first blog posts. The basic idea is that people do not value their gifts as much as they would be willing to spend on, or at least that they would have spent the cost of the gift in a Pareto-improving way. If instead of receiving a gift in kind one obtains a gift card, the added flexibility should give us a small to negligible deadweight loss. I would compare this to an incomplete market that can get close to complete, in well-being, with very few securities like government bonds.

Flóra Felsö and Adriaan Soetevent study spending habits of gift certificate recipients. They find that the vast majority is not really constrained by having to buy at a particular merchant and only alter a little bit the timing of their purchases. One in seven (more among females), though, considers the gift certificate separately from the budget constraint and buys something one could not afford. While these people are happy about it, there is obviously still a loss in well-being. Indeed, if they want this purchase so much, they would have bought it from the "normal" funds. All in all, the deadweight loss from gift certificates does not seem important.

House prices and consumption: how model specification matters

What is the impact of a decrease of house prices on consumption? If you go by the wealth hypothesis, one should see that home owners would reduce their consumption significantly because their wealth has suffered, while young renters are barely affected. According to the common factor hypothesis, both agent classes should respond in the same way, because they respond to common factors, for example future income prospects. It should be easy to test one hypothesis against the other and settle this. It turns out that using the exact same dataset, John Campbell and João Cocco could not reject the first, while Orazio Attanasio, Laura Blow, Robert Hamilton and Andrew Leicester could not reject the second. Well, that is embarrassing.

Annalisa Cristini and Almudena Sevilla Sanz replicate these results and show that because the two models are not nested, they cannot test against each other. Worse, it all boils down to the specification: estimate an Euler equation (which uses consumption growth) and the wealth hypothesis wins; estimate a consumption function, with consumption in levels, and the common factors hypothesis wins. So I am afraid it is not sufficient to estimate a single equation, one needs to estimate the whole structural model jointly.

About beer

Beer has been an important part of human well-being, and this for thousands of years. While the economic literature has dealt rather little with it, many great papers have significantly evolved at the pub. Still, I have previously reported on a conference on the Economics of beer, and open source beer.

Now, let us talk about the economic history of beer, thanks to Eline Poelmans and Johan Swinnen. Brewing in the middle ages was he realm of monasteries, with rather small output and a lot of product diversity. With technological advances and reduction in transportation costs, commercial breweries took over and especially over the last hundred years they lead a remarkable trend towards consolidation. After all those mergers and acquisitions, product diversity was considerably reduced. This is all changing now, and tastes have become more sophisticated and local micro-breweries are on the upswing. In some ways, beer has become more like wine.

How to tax addictions

Addiction is most often a problem of self-control. If one is not capable of factoring in the future consequences of one's actions, one way to make this is taken into account is to distort prices appropriately. This is what taxes (and subsidies) are good at. While we know rather well how to design taxes on externalities born by others or the community, the case is more difficult for externalities inflicted on future selves.

Luca Bossi, Paul Calcott and Vladimir Petkov get on the case i the context of externalities, self-control issues and imperfect competition, as applicable for cigarettes and their highly concentrated industry. They also implement time-consistent taxes to accommodate the addiction, which means that people or government would not want to deviate from the social optimum. Taxes are thus state dependent and described by a rule. One important result is that combining addiction and imperfect competition leads to lower taxes that previously reported, because prices are already higher to start with if providers are oligopolistic. Were some drugs to be legalized, one has thus to keep in mind that the new market structure matters in the design of the new taxes.

Is chocolate milk hip?

Sports and energy drink have become popular in the past decades or rather dubious grounds, as the recover and boost effect claimed in ads are in many cases false. See for example Vitamin water and Gatorade. In fact, plain water has much better recuperating properties than most of these sports drinks. And so does apparently chocolate milk, which has prompted marketing campaigns in the US with many athletes as spokespersons.

Senarath Dharmasena and Oral Capps, Jr. try to find the determinants of the demand for chocolate milk using a Heckman two-step demand model. Unfortunately, no regression results are presented, but the authors hint at a few interesting results. A quarter of all US households consume chocolate milk, with an average of 12 liters a year per household. Then they claim a number of household characteristics are significant, but with no indication in which way they are. For example, education of the household head is significant, and Hispanic household head as well. It would be interesting to know whether the relationship is positive or not. And as the authors ask in their title whether chocolate milk is the new-age sports drink, I am intrigued as how they could have answered this question. There is nothing in the paper itself about it.

Why am I reporting on such a thin paper? Because it always struck me how Europeans view adults drinking milk and especially chocolate milk as childish, while is it perfectly accepted in the US. I was wondering whether this difference could be seen in an empirical demand equation. Not in that one, though.

On the cost of financial crises

Are financial crises costly? To answer this question, one should not look at the cost of a bailout, a drop in GDP or missing tax revenue, but at what people care about: consumption. In this regard, the current crisis is too young to be analyzed, but other ones are available. Two recent papers look at this for Japan and Norway.

Yasuyuki Sawada, Kazumitsu Nawata, Masako Ii and Mark Lee use panel data from Japan that spans over the 1997 banking crisis and estimate Euler equation that allow for credit constraints. While in normal times, 7.82% of households are credit constraint, this increases only to 8.44% during the credit crunch. In other words, the ability for households to smooth out consumption was only negligibly affected.

Eilev Jansen studies Norway, but prefers a VAR approach linking current wealth and income to consumption, which appears to work better than Euler equation approaches for the recent years. But again, the impact of the crisis on consumption is negligible: the elasticity of equity income on consumption is 2%.

Thus, the impact on consumption seems to be minimal. So why again are we seeing these huge interventions?

Facts for heterogeneous agent macroeconomics

I rarely discuss material published in journals because I usually have seen it before in a working paper form. But sometimes you come across a great article, and in this case a special issue of the Review of Economic Dynamics. Nowadays, macroeconomics, at least the fresh water variety, is all about agent heterogeneity, and thus it is important to understand well the data these models are supposed to replicate. The special issue does this for nine countries, in an effort that tries to use uniform definitions and treatment of the data. In addition, data and programs are made available.

There is too much to write about for the whole special issue, so I will concentrate on the introduction by Dirk Krueger, Fabrizio Perri, Luigi Pistaferri and Giovanni Violante. They highlight that:

1. Wage disparity is lower where the labor market faces more institutional constraints.
   
2. The college premium is high everywhere.
   
3. Income inequality has increased.
   
4. Earnings inequality is larger than wage inequality.
   
5. Asset income and private transfers have no impact on inequality.
   
6. Government transfers affect inequality at the bottom, taxes at the top of the distribution.
   
7. Inequality in disposable income is larger than inequality in consumption.
   
8. Long-run changes in the inequality of discposable income are also larger than for consumption.
   
9. In recessions, inequality of earnings is more pronounced at the bottom of the distribution.
   
10. The same holds true for consumption.
    
11. Recessions have no impact on wealth inequality (we have to wait and see for the last one, though).
    
12. Inequality over the life cycle varies considerably across countries.
    

I found of particular interest the effort to reconcile micro-level consumption data with the national accounts. It is well known that there are discrepancies in the US and the UK for the growth of consumption, but apparently not elsewhere.

Posting calories in restaurants is Pareto improving

With increasing frequency, it is proposed that restaurants should post on their menus nutritional information. The restaurants resist this because they think it may shoo customers away, or at least make them eat less (assuming they underestimated the calories, which may not be always true). But if they eat less, why not make portions smaller and thus reduce costs and possibly increase profits?

Bryan Bollinger, Phillip Leslie and Alan Sorensen observed Starbucks outlets in New York City as such a calorie posting policy was implemented. They got data about each transaction in a NYC outlet for a 14-month period, including 11 months with calorie postings, as well as in Boston and Philadelphia, which act as control groups. They finding that the posting reduced calories per transaction by 14 units, 10 coming from fewer purchases and 4 from switching to a lower calorie item. You may think this would be bad for Starbucks? Think again, there was no significant change in revenue, in fact there was even a 3% increase for Starbucks outlets close to Dunkin Donuts: the calorie posting attracted clients from competitors.

Who buys online porn?

Not you, I know, but everyone must be curious about who would buy such a thing, especially as so much of it is available for free (and sometimes even without asking for it). Benjamin Edelman uses zip (postal) code data from subscriptions at a major provider of online adult entertainment to reveal some interesting insights. While he cannot know anything about the characteristics of those buying the services, he knows the characteristics of those living within the same zip code. Thus, we may learn something about the likely characteristics of the buyers, or about the composition of the social environment applying "peer-pressure" on the buyer.

Edelman finds that the highest share of buyers lies in Utah, a results well publicized in the media. But there is more to learn than this. In particular, religiosity has no impact, except that Sunday subscription starts are lower is religious zip codes. Political inclination, as measured by presidential votes, also has no impact (which may surprise people on way or the other). However, states that enacted more conservative provisions regarding the defense of marriage or were people have more conservative views of religion tend to have more subscribers. Other characteristics that lead to higher subscription rates: broadband access (although there could be reverse causality here), higher average household income, more young residents, more college degrees, less graduate degrees, urban areas, not yet married, more people engaged in community initiatives.

But one has to keep in mind that there is little variation of subscription rates, for example across states. The results above should therefore not allow you to establish whether your neighbor subscribes to dirty sites with much certainty.

Who bears the cost of fluctuations?

Now we are in a recession, who are those who will reduce their consumption the most? There are two obvious candidates: those who get unemployed and those were consuming a lot to start with. We know since the work of Jonathan Gruber, that consumption drops by 7% at the start of an unemployment spell despite unemployment insurance, and with a recession more people are unemployed. But, usually, those most likely to become unemployed in a recession are lower-skilled workers, who earn and consume less than average. A drop in aggregate consumption cannot be solely attributed to them.

Jonathan Parker and Annette Vissing-Jorgensen argue that those at the top of the consumption distribution suffer from very large fluctuations in consumption. Why would we care about the very rich? Because they influence aggregates and we seem to care about those. Also, this means that consumption inequality will be reduce considerably during this recession, even more than usual as the incomes of the very rich appear to be more affected than typically.

In their study, Parker and Vissing-Jorgensen find that the high correlation of individual and aggregate consumption of the very rich is a recent phenomenon. This is not due to the composition of their income, which is increasingly wage-based, as both individual capital and labor income are procyclical, and became more so recently. This should lay to rest the idea that rich households are able to smooth much better their consumption over the business cycle.

The impact of credit constraints

How important are credit constraints for households? This is not obvious to determine empirically due to a host of issues: one observes only successful applications, data centers typically on consumption, or it is about loans, it is based on opinion surveys that Economists are rightfully uneasy about. In a paper just published in the International Economic Review, Attanasio, Goldberg and Kyriazidou found a nifty way to address better the question.

Specifically, they exploit data in the Consumer Expenditure Survey that includes auto loans contracts. Credit constrained households are limited by how much they can borrow, and are little affected by interest rates. Those that are not constrained are able to optimize how much to borrow and are responding more strongly to interest rates. Think about it: the choices of the first is really determined by the kink in the budget constraint, and by its slope for the latter. The data they use contains large heterogeneity in interest rates and maturities, the latter being highly correlated with the size of the loan.

Results? Increasing maturity by one year increases loan demand by about 90%, and the demand elasticity with respect to the interest rate is undistinguishable from zero. These results are very strong and indicative of strong aggregate credit constraints. Age does not matter, surprisingly, but income does, obviously.

What does this mean? We know the permanent income hypothesis does not hold strictly due to credit constraints. A model with such constraints, however, should not pile them on the young, but on the poor.

How to spend the tax rebate

Out of curiosity, I recently checked what search engine keywords were bringing visitors to this blog. One thing that was puzzling me is the frequency of key phrases like "how to spent the tax rebate", "what to buy with tax rebate", and the like.

Why are people even asking these questions? There are two reasons: 1) it is tax filing season, and many people are getting a rebate for overpaid taxes. 2) people are trying to figure out how to spend the upcoming "gift" from the government. I find it scary that people would even ask how to spend that money. But in any case, here is my advice on how to spend it.

Don't.

It is that simple. If you have no particular purpose for that money and do not know what to do with it, save it! That may sound like a revolutionary concept in the United States where the aggregate savings rate is negative, but you should try it. Most people do not save enough for retirement. Given the government debt and the current fiscal deficits, taxes will have to go up at some point. So why not save ahead of these future tax increases (see the post on Ricardian Equivalence). And if you do not believe that these tax hikes will happen, then consider that government services will need to be cut significantly. So save for shock absorbers on your car, for a better alarm system, for your kids' education, even more for retirement, and constitute a rainy day fund for your health care.

And what about the "tax rebate" to be sent in a few months? My advice is: do not even think of spending it. Even if it is your patriotic duty to spend it. This tax rebate is not a rebate, it is an advance on the regular 2009 rebate. If you spend it, you may regret it during tax season in 2009.

PS: A hilarious spin on a serious issue: the proclamation of the Chattanooga mayor declaring today the "Give Our Georgia Friends a Drink Day".

Please stop with this silly stimulus package

In a previous post, I already detailed how (possibly) little impact on consumption a stimulus package may have. Economists tend to agree that the stimulus package is not the best idea out there, to give you an understatement, but politicians do not seem to listen to economists. That is their prerogative, but let me add a few arguments that they should be listening to, including some repeats.

1. A fiscal stimulus package has only a limited impact if people believe that tax will go back up, and the current situation is certain fertile for such beliefs
   
2. Imports are likely to absorb a portion of the (small) increase in consumption. China will be grateful.
   
3. Is the situation really so dire? Most indicators are still robust. There is no reason to panic. Obviously, if journalists react to a tiny 17,000 unit reduction in payrolls by claiming "Employment drops in a pink slip blizzard," it does not help.
   
4. Never have politicians managed to spend $150,000,000,000 with so little scrutiny, discussion and consultation of experts. Well, maybe with the Iraq war, but that is a different story.
   
5. Lack of consumption is certainly not the problem in the US, it is rather the lack of savings, with currently a negative aggregate savings rate. One should penalize consumption, not encourage it!
   

The Bush fiscal stimulus and Ricardo

Many bloggers are contributing to the debate on the fiscal stimulus the Bush administration is trying to push through. Let me add my grain of salt and discuss the effectiveness of this measure under various scenarios. I bypass here the question whether a stimulus is needed at all.

Given the current state of federal government finances, I take that this stimulus would be temporary, which is fairly obvious, and that it would need to be financed by further debt: it is not accompanied by a reduction in government expenses. This debt will have to be paid back at some point, through higher taxes. Thus we are in the typical case of a shifting of taxes through time, the basic premise for the Ricardian Equivalence.

The Ricardian Equivalence states that, under certain conditions, the intertemporal substitution of taxes has no impact on consumption and interest rates, and thus on other real macroeconomic aggregates except savings and government debt. Indeed, households realize after a tax cut that they will have to pay to pay higher taxes in the future, and thus save the tax cut for the future tax increase. They do so by buying the very bonds the government is issuing to finance the tax cut.

Now, this very strong theorem holds only under some stringent conditions, basically that welfare theorems hold (no distortionary taxation, complete financial markets, no monetary non-neutralities, etc.). These conditions are unlikely to hold in reality, so the empirical question is whether a tax cut does increase consumption or not (and the not includes a decrease). The literature is far from settled on this, but the two Bush administration have given several natural experiments to study this.

Case 1: Bush the elder implemented a stimulus package in 1993 that reduced the tax withheld from salaries, to be compensated by a lower tax refund the following year. A perfect experiment for the Ricardian Equivalence. According to Shapiro and Slemrod (1995), 43% percent of households spent the supplementary temporary income.

Case 2: Bush the younger issued to every US tax payer a rebate of US$300 or US$600 in 2001. Microstudies reveal that about 22% of households decided to spend it (Shapiro and Slemrod, 2001), or that between 20% and 40% of the rebate was spent (Johnson, Parker and Souleles, 2006). Looking at credit card spending, Agarwal, Liu and Souleles (2007) find again that about 40% was spent over the next nine months. For the 2003 tax cut, it impact on consumption is estimated at 50% by Coronado, Lupton and Sheiner (2005).

Thus, the Ricardian Equivalence does not seem to hold, but tax refund are clearly not the miracle measure to encourage consumption. Those households that actually spent the tax rebate where typically credit constraint: they wanted to consume more but could not for some reason, and the cash infusion relieved them from their constraint. For example, a young person, who would want to consume more but is unable to borrow against future income. Or a temporarily unemployed who, again, cannot find credit.

This means that for the fiscal stimulus to be most effective it should be directed towards those that are the most likely to spend it right away: the poor, the homeless, the students. Or the compulsive buyers. But not tax payers. It should not be a tax rebate, as those that pay taxes are those that have higher incomes, and are less likely to be financially constrained and thus consume.

The dead weight loss of Christmas

Sorry to rain in on all your Christmas cheer, but this period just bums me for the waste of resources it brings with it. I am all for people being generous to others and spreading wealth and happiness, but Christmas presents are just the wrong way to do it. Are the gifts you give to others truly the best use of the money the others would have made? Or, seen from the perspective of the gift receiver, would have bought something else with the the value of the gist I just received?

It turns out that the AER published back in 1993 a short article by Joel Waldfogel with the same title as this post. He surveyed Yale undergraduates to estimate how much the mismatching between the gifts and the wishes of the receivers were destroying the value of the gifts. Results: between 10% and 33% are lost. Losses are at the lower end of the interval for gifts from immediate family and friends, and at the upper end for extended family. Waldfogel finds also that cash gifts are more likely when losses are likely to be high, or when there is high variation in recipient valuation.

Waldfogel's results were controversial, first because the sample was drawn from a highly unrepresentative sample of the American population: Yale undergraduates (rich, young, dependent on parents). Also people seem to value a good more when it is received compared to self-bought. This can even result in a welfare gain from Christmas. Subsequent comments (rarely has a short article in the AER generated so much discussion in the AER) highlight that it is very difficult to measure anyway, and that the sequencing of the survey questions matters.

My take on this: I have the feeling that in many cases the original Waldfogel results are accurate. Just think of all the "gift stores" that sell crap you would not buy for yourself, but is good for giving to others. But I can believe that in some situations, the sentimental value of a gift makes up for the value. Think for example about diamonds: while the diamond industry managed to create the illusion they are worth a lot, their resell value is very low. Yet, all those women receiving diamonds are overjoyed, even when they should realize the hole it created in the household budget.

Once you remove the sentimental value of a gift, it is clear that there is a dead weight loss. This extends beyond Christmas. Imagine for example housing support for the poor, as it is common in the UK. Why give a housing subsidy? Wouldn't the poor be better off with a general subsidy?

Note also that gift buying typically happens in period where buying frenzy is encouraged by stores and media, at least in the United States. I can understand that it becomes difficult for some people to exercise restraint. Such unbridled consumerism can only add to the dead weight loss.

Media often comment how important good fourth quarter shopping results are for the economy. Well, the media is most likely wrong. I would prefer to have smaller seasonal effects and a better allocation of resources.