« In defense of (some) neuroeconomics | Main | Results I do not believe »
Tax rebates don't always work
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.
Posted by Tyler Cowen on January 18, 2008 at 09:37 PM in Economics | Permalink
Comments
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.
Posted by: srp at Jan 18, 2008 10:28:04 PM
Recommended reading: Richard Koo's "Balance Sheet Recession", which explained the failure of Japan's zero interest rate policy to prevent deflation and recession as being due to both individuals and businesses going into "balance sheet repair" mode, interested only in paying down debt and not wanting to take on more regardless of how cheap it was.
Of course it can't happen here ....
Posted by: jm at Jan 18, 2008 11:22:18 PM
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.
Posted by: Ronald Brak at Jan 19, 2008 3:40:09 AM
I just wonder how spending the money would help the economy in the first place....
Posted by: andy at Jan 19, 2008 4:49:55 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.
Posted by: odograph at Jan 19, 2008 6:28:11 AM
"I just wonder how spending the money would help the economy in the first place...."
Usually it's investing money and not spending it that improves an economy, so it's right to be wary of
politicians or others when they speak about boosting spending. It's not always a good thing. But when
there is a situation where a lot of people are starting to spend less money than usual, it can set off a
chain reaction that results in a recession or a depression. This is because if I spend less by say not
going to restaurants anymore, then the restaurant owners will take in less money, causing them to spend
less money on overtime for their workers, which means the waiters can't afford to come to my car yard and
purchase a car, which hurts my business and causes me to spend even less and so on. Obviously you want to
stop this self destructive cycle before it goes to far. Normally done by lowering interest rates, but a
well timed fiscal stimulus, such as giving money to people who are likely to spend it such as people
with children, can help stop the cycle. The trouble is, it's hard to know when is the best time for the
stimulus and the political process can result in the stimulus coming too late or not being very
effective. For example, in the U.S. it often goes to people who pay taxes but these people are less
likely to spend the money than people who don't pay taxes.
Posted by: Ronald Brak at Jan 19, 2008 7:38:31 AM
Isn't it the spending - at every level - consumer, business, government - that got us into this mess?
Posted by: meter at Jan 19, 2008 7:51:34 AM
I love the "early Spring" hypothesis of the politicos. Let's see, in 2006 the tax changes passed and were signed into law at Christmas time. The full IRS systems were not up and running until about April 15, with some problems not resolved until July. I wouldn't want to bet that the problems will be solved any quicker this year.
For the 2001 rebate, it came in three batches, starting at the end of July, as I recall, with the enabling legislation passing in early May.
From a practical standpoint, then, we are rally talking about this rebate appearing some time in the summer. Meanwhile we must ask how long and sharp this downturn is likely to be. By summertime, will this just be excess stimulus?
Posted by: Paul McMahon at Jan 19, 2008 8:13:47 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.
Posted by: Diversity at Jan 19, 2008 9:08:08 AM
It is clear that we need targeted government handouts that will actually be consumed. In my personal situation what would work is a gift card to Ritz Camera so I can buy the new Nikon D300 that I have been trying to justify. The way I see it, my hesitation to make this totally unnecessary expenditure is the tipping point that is forcing us into recession.
Once the echoes of that purchase die away, it may be necessary to provide me with a gift card to the apple store to really kick start the economy.
Posted by: RobbL at Jan 19, 2008 9:23:57 AM
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?
Posted by: dWj at Jan 19, 2008 12:17:36 PM
I do not know if this is a good source, http://www.cbpp.org/3-8-06tax.htm , but the Center on Budget and Policy Priorities has extensive reports on why a tax cut does not recover lost revenues. Also, http://www.cbpp.org/9-27-06tax.htm , tries to dispel "myths" of a tax cut.
Posted by: brainwarped at Jan 19, 2008 1:23:52 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.
Posted by: Arr-squared at Jan 19, 2008 4:54:25 PM
What if the rebate came in the form of a Visa/Mastercard debit card?
I bet the convenience factor would lead many to spend it compared to receiving a check.
Posted by: Scott at Jan 22, 2008 12:31:16 PM
