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Tax rebates: Even those who saved ended up spending

Daniel Ray

President George Bush made tax cuts an important part of his 2000 campaign, and delivered one in 2001. About two-thirds of U.S. tax-filers received tax rebates, typically $600 for couples and $300 for singles, for an average gain of about $500 per recipient household. What do you think people did with it, spend or save? In a newly released paper from the Philadelphia Federal Reserve, three economists have an answer: both.

The rebate checks were disbursed over 10 successive weeks from July through September 2001, depending on the second-to-last digit of the recipients’ Social Security numbers. That distribution via random number really got the economists worked up.

I’ve read a lot of economic papers, and rarely do economists display such excitement as exhibited by Chunlin Liu, Sumit Agarwal and Nicholas Souleles in their paper, “The Reaction of Consumer Spending and Debt to Tax Rebates: Evidence from Consumer Credit Data.”

They write, “Because this penultimate digit is randomly assigned, the timing of rebate receipt represents truly exogenous variation. Such randomization is quite rare in the history of fiscal policy and provides a unique natural experiment that cleanly identifies the causal effects of the rebates.” Whew! Easy, tigers. Am I going to have to hose you off?

If you’re not fluent in economese, they’re saying this is good, randomized data, the kind you can’t often find, the kind that lends itself to good conclusions. Fair ’nuff.

Their conclusions: “We find that, on average, consumers initially saved some of the rebate, by increasing their credit card payments and thereby paying down debt and increasing their liquidity. But soon afterward their spending increased, counter to the LCPI [Life Cycle Permanent Income] model and Ricardian Equivalence.” Whoa! In your face, LCPI! Eat my dust, Ricardian!

OK, guys, I’ve had enough fun at your expense. To be honest, it’s exciting to see economists get worked up. The last economics party I went to was “The Dismal Ball,” and I was home at 8. But I digress.The important point is this: Even those who did their best to use the tax rebate to beat down credit card debt ended up racking up more credit card debt shortly after. Those who, in economic terms, were “liquidity constrained,” that is, pretty much maxed out, were most likely to spend their rebates. On average, debt went down for a few months. But by the fourth month, debt leveled off, as spending picked up and extra payments fell. By nine months after the rebate, overall debt was higher than it was before.

Does that mean the tax rebate made us worse off than before in terms of debt? That’s only sort of true, and only for a subset of people, says Liu, assistant professor of finance at the University of Nevada-Reno. What he found important was the portrait the data paint of “liquidity constrained” people — that is, young folks with their cards nearly maxed out.

“Let’s say I have a credit card, I’m liquidity constrained,” he tells me. “What that means is I want to spend but I can’t because my balance is close to the limit. So when I receive a rebate, of course what I’m going to do is deposit it in the bank and pay down the debt from my credit card. So if I pay down debt, after that, I can spend on my card again!”

The conclusions don’t surprise me, but the LCPI model is pouring itself a stiff drink right about now.

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