Working Paper: NBER ID: w20437
Authors: Lorenz Kueng
Abstract: Although theoretical models of household behavior often emphasize fiscal foresight, empirical studies of household consumption have yet to document the role of news about tax changes. Using novel high-frequency bond data, I develop a model of the term structure of municipal yield spreads as a function of future top income tax rates and a risk premium. Testing the model using the presidential elections of 1992 and 2000 as two quasi-natural experiments shows that financial markets forecast future tax rates remarkably well in both the short and long run. Combining these market-based tax expectations with data from the Consumer Expenditure Survey, I find that spending of higher-income households increases by close to 1% in response to news of a 1% increase in expected after-tax lifetime (permanent) income. These findings imply that by ignoring anticipation effects, previous estimates of the total effect of a tax change could be substantially biased.
Keywords: household spending; tax changes; fiscal foresight; anticipation effects
JEL Codes: E21; E62; G12; H31; H74
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| financial markets forecast future tax rates effectively (G17) | household spending behavior (D12) |
| 1% increase in expected after-tax lifetime permanent income (D15) | spending of higher-income households increases by approximately 1% (D12) |
| anticipated tax changes (H26) | household consumption decisions (D10) |
| elasticity of consumption with respect to anticipated tax changes is about 1 (H31) | one-for-one response in household spending to changes in expected after-tax income (H31) |