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American Economic Journal: Macroeconomics: Vol. 6 No. 1 (January 2014)

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Can Tax Rebates Stimulate Consumption Spending in a Life-Cycle Model?

Article Citation

Huntley, Jonathan, and Valentina Michelangeli. 2014. "Can Tax Rebates Stimulate Consumption Spending in a Life-Cycle Model?" American Economic Journal: Macroeconomics, 6(1): 162-89.

DOI: 10.1257/mac.6.1.162

Abstract

We build a life-cycle model with earnings risk, liquidity constraints, and portfolio choice over tax-deferred and taxable assets to evaluate how household consumption changes in response to shocks to transitory anticipated income, such as the 2001 income tax rebate. Households optimally invest in tax-deferred assets, which are encumbered by withdrawal penalties, and exchange taxable precautionary savings for higher after-tax returns. The model predicts a higher marginal propensity to consume out of a rebate than is predicted by a standard frictionless life-cycle model. Liquidity-constrained households—with few financial assets or portfolios expensive to reallocate—consume a higher fraction of the rebates.

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Authors

Huntley, Jonathan (US Congressional Budget Office)
Michelangeli, Valentina (Banca d'Italia)

JEL Classifications

D91: Intertemporal Household Choice; Life Cycle Models and Saving
E21: Macroeconomics: Consumption; Saving; Wealth
G11: Portfolio Choice; Investment Decisions
H24: Personal Income and Other Nonbusiness Taxes and Subsidies; includes inheritance and gift taxes

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