The University Record, December 10, 2001

Most Americans are stashing tax rebate for rainy day

By Bernie DeGroat
News and Information Services

Only about 22 percent of Americans who received federal income tax rebates in the past few months spent or expect to spend some or all the money. Instead, a majority are saving the money or using it to pay off debt, say U-M economists.

In their survey of 1,500 U.S. households, researchers Matthew D. Shapiro and Joel Slemrod not only found that a small number of rebate recipients intended to increase their spending, but that the overall response from consumers is a genuine departure from previous spending habits.

“This very low rate of spending represents a striking break with past behavior, which would have suggested a much higher rate of spending,” says Shapiro, a professor in the Department of Economics. “The low spending rate implies that the tax rebate will provide a very limited stimulus to aggregate demand.”

For comparison, a 1995 study by Shapiro and Slemrod showed that 43 percent of American consumers spent the extra cash resulting from a 1992 executive order that changed income tax withholding rates to increase after-tax income by about $29 per month.

According to the current study, among those who said that they would not spend their tax rebate, 59 percent indicated that they would repay debt, while 41 percent said they would save it. Among those who said that they would spend the rebate, 60 percent planned to use it for day-to-day expenses and 40 percent intended to buy a particular item.

“Spending plans for the rebate do not depend on household income,” Shapiro says. “In particular, low-income households are not more likely to spend the rebate. This suggests that targeting any additional tax rebate to particular income groups may not improve the effectiveness of a tax cut in stimulating the economy.”

The researchers say that most households expect the whole package of federal tax legislation, including large cuts in tax rates, to have no effect on their overall personal finances over the next decade and that most are equally pessimistic about the prospects for the tax cut improving short-run economic performance.

Moreover, only 19 percent of households expect a cut in government spending to accompany the tax reductions, which may help explain why, on average, the propensity to spend the tax rebate is low, they add.

Regardless of the reasons for the low rate of spending, Shapiro and Slemrod say that their findings have significant implications for the impact of fiscal policy on the economy.

“The low propensity to consume implies that the tax rebate is having a very small impact on aggregate demand,” says Slemrod, a professor of business economics and director of the Office of Tax Policy Research at the Business School. “The rebate was added to the 2001 tax bill explicitly to provide a short-run stimulus, but our research suggests that it has provided little economic stimulus.

“Additional rebates are being proposed as part of the post-Sept. 11 stimulus package, but these will likely have only a small effect on consumer spending.”

Consumers’ reluctance to spend also raises a cautionary note about the efficacy of fiscal policy and that key parameters based on aggregate conditions may be difficult to anticipate, Slemrod adds.

“One can speculate about why the spending propensity might have shifted downward under the circumstances of mid-year 2001,” he says. “Perhaps the negative shocks to wealth of the previous two years placed consumers in an asset-building mode and they took advantage of the rebate checks to do that.”