Likely Effects of the Tax Rebate Checks

Following my recent musings about the tax rebate checks, several people asked about the likely economic consequences of this sort of policy.

My friend and colleague, Nick Souleles, is one of the leading experts on these matters, so I asked him for a short primer on what we learned from when rebate checks were sent out in 2001.

Here is a list of three of the best recent contributions, in chronological order. Taken as a group, they both provide some useful guidance, and highlight remaining uncertainties — and the thing I really like is how these papers highlight some of the ways in which economists are willing to get their hands dirty with some particularly innovative research strategies.

1. “Consumer Response to Tax Rebates,” by Matthew Shapiro and Joel Slemrod, American Economic Review, 93(1), March 2003.

The authors use a fairly direct way of figuring out the effects of the 2001 rebate checks: They ask people.

The answer: Around one-quarter planned on spending it, one-third planned to save, and the rest were planning on using it to pay off debt. Interestingly, the rich were more likely to spend the rebate, while those on lower incomes planned on paying off debt.

2. “Household Expenditure and the Income Tax Rebates of 2001,” by David Johnson, Jonathan Parker and Nicholas Souleles, American Economic Review, 96(5), December 2006. A nice summary from the N.B.E.R. Reporter is available here.

This paper shows some real ingenuity: the authors note that the 2001 tax rebate checks were sent out over a ten-week period, with the date depending on the second-to-last digit of your social security number, which is effectively a random number. Sensing a research opportunity, the authors persuaded the B.L.S. to add some questions to the Consumer Expenditure Survey, allowing them to compare the timing of the rebate payment and the timing of expenditures.

All told, they estimate that on average around two-thirds of the rebate was spent during the ten-week disbursement period and the subsequent three months. Interestingly, around a third of the total response came from a rise in spending on clothes.

3. “The Reaction of Consumer Spending and Debt to Tax Rebates — Evidence from Consumer Credit Data,” by Sumit Agarwal, Chunlin Liu and Nicholas Souleles, Journal of Political Economy, 115(6), December 2007 (un-gated version here).

This paper begins with one particularly compelling observation: credit card companies know our social security numbers (and hence who got their rebates when), and they also know a lot about our spending and saving patterns.

And so once the authors were able to get a large credit card company to share with them (anonymized) data, their research project was made.

Recall that paper #1 had found that nearly half of all respondents expected to use the rebate to pay down their debt. It turns out that this was the initial response of many, but then over the ensuing nine months, spending rose by enough to account for around two-fifths of the average rebate. And for those who were liquidity constrained, spending rose even further.


John Jay

to poster#1: Yes, if money is borrowed to return to taxpayers, as this rebate and all tax cuts since Reagan have been, whoever it was borrowed from in the first place will not be spending it.

Long after the flat screen TV or Japanese car is junked, we'll still owe the debt and it's repayment will drag down some future taxpayer's ability to sustain the economy.

TaxForWar

The rebate only reduces taxes owed, so if you owe on this year's taxes (or previous years' taxes on a payment plan) you have no choice about where the money will be spent. The government will reduce the amount you owe them by that amount and you won't see a dime. If you owe nothing to the IRS, then you will get a check.

Pete S

Ray G, this isn't really taxpayer's money. It is in fact money borrowed from investors in Hong Kong.

wb

This time around, the rich aren't getting a rebate, and many non-taxpayers are. That will skew the results.

Our family makes too much to get the rebate, as we have had a good income the past two years. But our income may be transient, so we don't live like we have excess money or take on debt our more-reliable income would support.

Ray G

I particularly like the attention that these kinds of studies give in that everyone seems to be trying to gauge the wisdom of giving back tax-payer money based on what they do with it.

Perhaps we should be like the British and their attitude towards Hong Kong during the formative years. Don't ask what they're doing with it; it's theirs, just give it back. (This still leaves out the wealthier tax payers who don't receive a check, but it's a start, and the principle is correct.)

Michael

I question the applicability of the first study. First of all, in 2001 tax payers were given an actual rebate, whereas this time around, we're paid the same regardless of actual taxes paid. Second, the 2001 tax rebate was accompanied by a tax cut, and the main question regarding how tax payers were planning on using the rebate incorporated this fact into the wording (they were assuming the Barro/Ricardo hypothesis). Third, I wonder whether an answer to the question imparts any useful knowledge. People might be more likely to say they will pay off debt when asked over the phone as it sounds like a more fiscally responsible thing to do (note that they were asked how the PLANNED TO SPEND the money, not how they SPENT the money). Also, last I checked, cash is pretty fungible. I doubt anyone puts together a comprehensive budget for the upcoming tax year, and then when an unexpected windfall comes in, then earmarks that money for a particular purpose.

It seems like the latter two studies use a more reasonable methodology given my final point (although, their comparison still suffers from the first point)

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masayaNYC

Why doesn't the gov't just give the money directly to credit card companies and use it to extend/improve consumers' credit? Maybe that'd help the financial health of your average consumer, rather than retail stores and credit card companies feeding off our consumerist society's need for more more more spending.

liberalarts

@3 Michael,
In the age of our grandparents, economic downturns were both more frequent and more painful. Improved access to consumer credit has probably contributed to the smoothing of the business cycle, and that very process means that these tax rebates will have less of an impact than they would have 50 years ago.

chad

So if I am reading this correctly what the data shows is that the tax rebates were effective in increasing spending.

Is there any reason to suppose that this set of rebates won't have a similar effect?

Michael Williams

What happened to the days of our grandparents when people actually had the money for something before they bought it? Are we doomed forever to live in a world in which 90% of the American population buys things they can't afford on credit cards and then goes into financial crisis every time the economy has a downturn?

Julie

As I recall, the last rebates were send out just in time for "Back to School" shopping. That would explain the increased spending on clothing. With a son and daughter in high school during that period, that's where my check went.

Rob Adams

I feel I should point out that anonymizing data of this type is more or less impossible to do, so that credit card company was taking a huge risk giving out this data.

mikenyc2001

this is a trick to fool the public, the poor will buy more silly things or designer outfits, but in reality when your down and out whats the difference with tossing 300 to 600 on liquor when that same amount will be eaten up on fees, charges and crap when your default on your loans and credit cards anyway.

Ray G

John Jay:

The government should cease issuing bonds then?

iratecat

Ray G:
If I understand correctly, bonds are essentially chunks of government debt sold to whomever to fund stuffs, and they are paid back later using money collected from taxpayers.
So, since I am and will be for the next sixty years a taxpayer, my answer is going to be... yes, I'd like the government to not rack up so much friggin' debt that I'll have to pay for later.

David G

Here is the thing, we, or some of us get a check for $1200 we spend some, save some and pay off some debt. Then what? Will this spurt of economic activity jump start the economy if wages are stagnant, gas prices are at $4.20 a gallon, food prices continue to increase and the dollar continues to weaken? I would think not. Ten weeks from now, or when the next round of quarterly earning reports come out there might be a little better news from a short round of spending, but lets not kid ourselves, the larger picture is not all that great, the government is broke, leadership is afraid to raise taxes because ya can't get elected raising peoples taxes, debt will continue to grow, keeping the value of the dollar low, making oil more expensive and the whole thing just keeps rolling along. So call me a pessimist right now but until we have leadership who is willing to do what is right rather than what is going to get them elected next term we are in trouble...can anyone say 18 cents a gallon tax holiday....

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David E

I find this pretty interesting about what our government is trying to accomplish. This effort to stimulate the economy seems like a desperate attempt by our government to help dig themselves out of a hole. I will have to agree with David G on how this may increase the quarterly earnings but in the long run it wont do much good. Sure it will increase the consumer expenditure on the GDP but it will have no positive long term effect. As a college student perspective (Currently a student) I can say that the money my wife and I will receive will most definitely go towards our debt we have accrued while being in school. I know we wont contribute to company's quarterly earnings in anyway. So if it was the governments hope for us to purchase things, mission failed.

As long as gas prices stay the way they are I don't see in the near future of much economic growth in our country. Leaders of America need to help this country get out of debt, not put us further in debt with these radical ideas, and promises, to help them be elected as President.

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james kingdom

Isn't this a bit like short-term tax reductions, in that consumers are unlikely to increase spending if they are pessimistic about future prospects and are aware of the short-term nature of the arrangement?

If recipients are aware that a major recession is looming they may well pay off debt or save instead of spending.

Brenda

Great. Korean kids are proud to study and learn 5 languages while teaching themselves AP courses in their "spare" time ... Americans are, um, holding their breath waiting on their government checks. Pop quiz: who will be running the world in 20 years? (

CBD

The economy has evolved since 2001; our problems and the participants of this economy have changed. Although the studies of the past are relevant, I would be more interested in conducting the same studies again to get a real-time sense of what's going to happen.