Did the 2001 Tax Rebate Checks Stimulate Consumption? The Economic Evidence

January 21, 2008

“Stimulus” is the word of the day in Washington. And tax rebate checks have been the most frequently cited possibilities for financing such a stimulus. But in order for a supposed stimulus to “work,” tax rebate checks must lead to short-term real increases in consumption. So will they?

We can let recent history be our guide. Below are links to some academic papers on the question of whether or not people spent their rebate checks they received in 2001.

Did the 2001 Tax Rebate Stimulate Spending? Evidence from Taxpayer Surveys“, by Matthew Shapiro and Joel Slemrod. The conclusion:

The tax rebates sent out in the summer and early autumn of 2001 were a small part of the 10-year tax cut bill that became law earlier that year. Although not originally part of the tax cut plan, as an economic slowdown became more apparent, one part of the tax cut for 2001 was converted into more visible checks sent out to taxpayer rather than reductions in withholding. One might speculate that incumbent politicians also guessed that household-voters would be more likely to recall their largesse if the tax cut took the form of a check as opposed to, for example, a reduction in tax withholding.

Did they work as a counter-recession policy? The answer to that question depends in part on households’ propensity to consume out of the increased disposable income due to the rebates. Our survey-based research suggests that the spending rate was quite low compared to what many economists had expected. This finding appears in a contemporaneous survey and a retrospective survey that addressed the actual rebate plan. It also appears in answers to what would be the response to a hypothetical survey conducted soon after September 11. An examination of the NIPA data is completely consistent with a small impact on consumption. Yet, because it is impossible to know what consumption would have been absent the rebates, aggregative analysis cannot be definitive. Nonetheless, that the counterfactual in aggregate data gives a similar result to the counterfactual that we pose to survey respondent is significant validation of the survey methodology.

Another paper on this issue by Shapiro and Slemrod appeared in AER. Here is the abstract:

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.

A study by Parker and Souleles suggests a larger response by American consumers to the rebate checks. Here is their abstract:

Under the Economic Growth and Tax Relief Reconciliation Act of 2001, most U.S. taxpayers received a tax rebate between July and September, 2001. The week in which the rebate was mailed was based on the second-to-last digit of the taxpayer’s Social Security number, a digit that is effectively randomly assigned. Using special questions about the rebates added to the Consumer Expenditure Survey, we exploit this historically unique experiment to measure the change in consumption expenditures caused by receipt of the rebate and to test the Permanent Income Hypothesis and related models. We find that households spent about 20-40 percent of their rebates on non-durable goods during the three-month period in which their rebates were received, and roughly another third of their rebates during the subsequent three-month period. The implied effects on aggregate consumption demand are significant. The estimated responses are largest for households with relatively low liquid wealth and low income, consistent with liquidity constraints.

For more on the economic research of consumption, check out a previous recent blog post on the issue.

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