Congressional Budget Office. “Options for Responding to Short-Term Economic Weakness”. January 2008 – “Households. In general, tax cuts or increases in transfer payments from the government to people (such as Food Stamps or unemployment insurance benefits) increase household demand by providing consumers with additional spending power. The bigger the chunk of that additional income that consumers are willing to spend instead of save, the more stimulus there will be from a particular tax reduction or increase in government transfer payments. But households do not predictably spend a fixed proportion of the extra income left in their hands when taxes are reduced or transfers are increased. Rather, a household’s propensity to consume appears to vary with its income and depends on expectations of the household of what will happen to that income over the longer term. A household’s consumption also varies for other reasons that are little understood.
Households are particularly likely to spend a greater share of a temporary reduction in taxes or additional transfer payments if they are credit constrained (that is, they have borrowed as much money as creditors will lend them). Given that these households would probably borrow additional money if given the opportunity, they are unlikely to save additional income. They are therefore likely to spend a greater proportion of a tax reduction or a transfer increase than other people who have access to credit. Lower-income households are more likely to be credit constrained and more likely to be among those with the highest propensity to spend. Therefore, policies aimed at lower-income households tend to have greater stimulative effects.
Two recent studies that evaluate household spending following the 2001 tax rebate offer historical evidence consistent with this view. In one study, the authors examine households categorized by income and liquid assets. Although the results are not definitive, low-income households and those with few liquid assets appear to have increased their consumption far more in response to the tax rebate than households with higher income or more liquid assets.9 For example, low-income households were estimated to have increased spending on nondurable goods by more than the amount of the rebate in the three-month period during which it was received, while middle-income households increased the same type of spending by less than 20 percent of the rebate amount. Households with few liquid assets were also estimated to increase spending on nondurables by more than the rebate amount, while those with a medium or higher level of assets were estimated to have decreased such spending.
The other study, which looked at households’ credit card usage, concluded that households with lower credit card limits, those with credit card balances near the limit, and those that used their cards intensively increased credit card spending much more than other households in the nine months after receiving their rebates.10 For example, households with credit limits under $7,000 increased spending by more than $140 after receiving the rebates (which were typically between $300 and $600), while those with credit limits above $10,500 increased spending by only $40. Households with balances above 90 percent of their credit limit increased spending by more than $330, while those with balances between 1 percent and 50 percent of their credit limits increased spending by less than $20.”
Treasury Secretary Hank Paulson defended the 2008 tax rebate stimulus plan on the basis that the 2001 tax rebates were successful, which gave $300 per individual and $600 per family in a 2001 – “The evidence was that people spent between a third and two-thirds of the money and spent it quickly,”
Federal Reserve Chairman Ben Bernanke:“Fed Chairman Backs Stimulus”. Washington Post. January 18, 2008 – “The Fed chairman did state some principles for what kinds of policies would do the most to keep the economy from slowing too drastically in 2008. He called the stimulus packages being considered, $50 billion to $150 billion, ‘reasonable.’ And he indicated that money provided to low- and moderate-income Americans is likely to result in more new economic activity than funds that go to people with high incomes.”
“Getting money to low and moderate income people is good in the sense of getting a bang for the buck,”
The study should provide fuel for the stimulus debate already consuming lawmakers.
It said lump-sum tax rebates like the $300-600 rebates delivered to taxpayers seven years ago are among the more cost-effective ways for Congress to jump-start the economy, though CBO cautioned that rebates are more effective when given to middle- and lower-income taxpayers more likely to spend it.
CBO also gave high marks to cash payments to the poor and the unemployed as cost-effective ways to stimulate the economy. During recessions, Congress regularly extends unemployment benefits beyond the 26-week limit. Democrats are eyeing a temporary boost in food stamp benefits.
‘When the economy is weak, the key impediment to economic growth is how much demand there is,’ CBO Director Peter Orszag said in an interview. ‘And from that perspective what you want to do is get money to people who are going to spend it really fast.'”