Tax News Shocks and Consumption

48 Pages Posted: 12 Mar 2016 Last revised: 4 May 2020

See all articles by Lorenz Kueng

Lorenz Kueng

University of Lugano - Faculty of Economics; Swiss Finance Institute; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR); Northwestern University - Kellogg School of Management

Date Written: August 21, 2018

Abstract

How predictable are personal income tax rates in the U.S., and does household spending respond to news about future taxes even before the rates change? To answer these questions, this paper uses novel historical high-frequency data of tax-exempt municipal bonds and develops a model of the term structure of municipal yield spreads to taxable bonds as a function of future top income tax rates and a risk premium. Testing the model using the presidential elections of 1980, 1992 and 2000 shows that financial markets forecast future tax reforms remarkably well in both the short and long run. Combining these market-based tax expectations or "tax news shocks'' with data from the Consumer Expenditure Survey shows strong evidence of anticipation effects to future tax changes among higher-income consumers, well before the tax rates change. Consumer spending changes about one-for-one with changes in expected lifetime tax liabilities. These findings imply that ignoring anticipation effects can substantially bias estimates of the total effect of a tax change.

Keywords: expected taxes, municipal yields, household consumption.

JEL Classification: E21,G12, H31

Suggested Citation

Kueng, Lorenz, Tax News Shocks and Consumption (August 21, 2018). Swiss Finance Institute Research Paper No. 20-30. Available at SSRN: https://ssrn.com/abstract=2746486 or http://dx.doi.org/10.2139/ssrn.2746486

Lorenz Kueng (Contact Author)

University of Lugano - Faculty of Economics

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