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.
Huntley, Jonathan, and Valentina Michelangeli.
"Can Tax Rebates Stimulate Consumption Spending in a Life-Cycle Model?"
American Economic Journal: Macroeconomics,
Intertemporal Household Choice; Life Cycle Models and Saving
Macroeconomics: Consumption; Saving; Wealth
Portfolio Choice; Investment Decisions
Personal Income and Other Nonbusiness Taxes and Subsidies; includes inheritance and gift taxes