How Households Responded to Tax Rebates of 2001

the [tax] rebates did increase consumer spending significantly, helping to end the recession of 2001.

In March 2001, the U.S. economy entered a recession. In response, the Economic Growth and Tax Relief Reconciliation Act of 2001 included a large income tax rebate program intended to stimulate consumption demand and ameliorate the recession. The program sent tax rebates, typically $300 or $600 in value, to about two-thirds of U.S. households. Because there have been relatively few instances of such active, counter-cyclical fiscal policies in U.S. history, there was little evidence available on whether this rebate program would indeed help to end the recession. In other words, how much of their rebates would consumers spend?

Economic theory is generally pessimistic about the efficacy of such counter-cyclical tax policies. According to the rational-expectations Permanent-Income Hypothesis, households should decide on a level of consumption based on a long-term view of their resources. In this case, a single rebate would have little effect on spending. Further, the theory predicts that, in the absence of liquidity constraints, spending should increase as soon as consumers begin to expect some tax cut, and not increase only after they actually have received the rebate check.

Shortly after the passage of the 2001 Tax Act, David Johnson, Jonathan Parker, and Nicholas Souleles, working with the Bureau of Labor Statistics and other government agencies, added a special group of questions about the tax rebates to the Consumer Expenditure Survey, the most comprehensive ongoing measure of U.S. household expenditure. In Household Expenditure and the Income Tax Rebates of 2001 (NBER Working Paper No. 10784), they analyze the responses to these questions, and conclude that the rebates did increase consumer spending significantly, helping to end the recession of 2001.

Their analysis uses a unique feature of the rebate program. Because it was administratively difficult to print and mail the rebate checks all at once, they were mailed out over a ten-week period from late July to the end of September 2001. Most importantly, the particular week in which a check was mailed depended on the second-to-last digit of the taxpayer's Social Security number, a number that is effectively randomly assigned. This randomization allows the authors to identify the causal effect of the rebate by comparing the spending of households that received the rebate earlier to the spending of households that received it later. This also allows the rebates to be distinguished from other concurrent factors that affect consumption and might otherwise confound inference about the rebate (for example, concurrent changes in monetary policy, or the stock market, or the advent of zero-percent auto financing, and so on).

The authors find that "the average household spent 20-40 percent of its 2001 tax rebate on non-durable goods during the three-month period in which the rebate was received." Further, "[r]oughly two-thirds of the rebates were spent during the quarter of receipt and subsequent three-month period." In dollar terms, households increased their expenditures on food by $51 and their expenditures on non-durable goods by $179 on average in the quarter of receipt, which correspond to a 2.7 percent rise in expenditures on food and a 3.2 percent rise in expenditures on non-durable goods. These findings run counter to the Permanent-Income Hypothesis.

The authors also investigate whether some households were more likely to spend the rebate than others. They find that "[t]he expenditure responses are largest for households with relatively low liquid wealth and low income, which is consistent with liquidity constraints."

In all, the rebates totaled $38 billion, or about 7.5 percent of personal consumption expenditures on nondurable goods in the third quarter of 2001. The authors' estimates imply that the rebates increased aggregate consumption expenditures on nondurable goods by 2.9 percent and 2.0 percent in the third and fourth quarters of 2001. The timing and magnitude of this response is consistent with the rebate program playing a large role in counteracting the 2001 recession, which ended in the fourth quarter with strong growth in aggregate consumption.