On the Effectiveness of Tax Rebates

A paper by David S. Johnson, Jonathan A. Parker, and Nicholas S. Souleles argues that tax rebates (like the ones being proposed in the current bipartisan stimulus package) are effective in boosting household expenditure and increasing aggregate demand. Here's the abstract:

During 2001, most U.S. taxpayers were mailed a Federal tax rebate in a randomly assigned week between July and September. Using special questions added to the Consumer Expenditure Survey, we use 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. Households spent about 20-40 percent of their rebates on non-durable goods during the three-month period in which they received their rebates, and roughly two-thirds of
their rebates cumulatively during the quarter of receipt and subsequent three-month period. The implied effects on aggregate consumption demand are substantial. Responses are larger for households with low liquid wealth or low income, consistent with liquidity constraints.

I haven't read through the entirety of the paper or attempted to comprehend its methodology, but I can say that if we're going to use the 2001 rebate example as a model for the stimulus package, we need to take into account the fact that, even as the article mentions, families with lower-incomes respond greater to the benefits. Intuitively, this makes sense, as those with lower-incomes would need to spend more, hence providing those households with the most financial aid (as the Democrats initially intended) would have been wiser. Here's Paul Krugman on the subject:

The goal of a stimulus plan should be to support overall spending, so as to avert or limit the depth of a recession. If the money the government lays out doesn’t get spent — if it just gets added to people’s bank accounts or used to pay off debts — the plan will have failed.

And sending checks to people in good financial shape does little or nothing to increase overall spending. People who have good incomes, good credit and secure employment make spending decisions based on their long-term earning power rather than the size of their latest paycheck. Give such people a few hundred extra dollars, and they’ll just put it in the bank.

In fact, that appears to be what mainly happened to the tax rebates affluent Americans received during the last recession in 2001.

And there's this from his blog:

I’d guess that the top two quintiles are unlikely to be liquidity-constrained, so the rebate will have little effect on their spending. But they get 58% of the money. The bottom two quintiles, which are the place you’d most expect to have an impact, get only 21% of the money. Split the difference on the middle quintile, and you’ve got a plan where around 2/3 of the outlay is likely to be ineffective.

The bottom line is simply this: economists seem to be in virtual agreement that the stimulus package will do something to ease the projected economic recession, though they are not harmonious as to what. I personally take Krugman's side in thinking that it is a little bit better than nothing, but not nearly as efficient as it could have been had it been geared more towards the economically disadvantaged.