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Dec 12 2007 12:15PM EST

How Were the Bush Tax Rebates Spent?

Under President Bush's 2001 tax cuts, some $38 billion in tax rebates were sent to 89.5 million tax filers. The rebates amounted to about 2 percent of what consumers typically spend every three months. Singles could expect to receive a maximum of $300 and couples a maximum of $600.

In a new paper, Sumit Agarwal of the Chicago Fed, Chunlin Liu of the University of Nevada, and Nicholas S. Souleles of Wharton used data from 75,000 credit card accounts as a proxy for what tax filers did with their rebates.

Standard economic theory tells us that consumers smooth their spending habits over a lifetime. Part of what that means is when consumers receive a temporary spike in income, spending shouldn't necessarily rise because rational humans would be expected to keep that extra money around for less luckier times.

The trio found that consumers did initially save some of the rebate by paying down debt, but then increased spending by an average of $200 in the following nine months. They also found that consumers without easy access to credit (likely to be lower income) were much more likely to spend their refund (average expenditure here was estimated at $333) while the more well-off were more likely to save theirs.

The results are inline with another recent paper which found that consumers spent on average two-thirds of their rebates.

What the findings reveal is that the standard theory on saving, which draws on the work of Milton Friedman and Franco Modigliani, don't do a good job of predicting how people without easy access to debt react to income windfalls.

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