Even little changes in income tax policy have a big impact on spending, according to new evidence presented by Nicholas Souleles, assistant professor of finance, at a lunch-time seminar sponsored by Wharton's Public Policy and Management Department at Steinberg-Dietrich Hall, Sept. 26.

Souleles studied consumption patterns of 8,000 households that received federal income tax refunds in one of the years between 1980 to 1991. His survey revealed that the poor and the wealthy spent a large amount of their refunds within three months of receiving them. Both groups treated the tax refunds as windfalls, and not as regular income.

Souleles found that wealthier people spent their refunds differently from poorer people, even though they all behaved as if the refunds were found money.

The poorer people used refunds to buy things such as food and clothing they couldn't buy before because they didn't have the cash. But those with higher incomes, who had money to spend even before the refund, spent half the money they received on high-ticket items such as new vehicles.

"The most rational goal would be to consume evenly regardless of variations in income, that is, not to go from feast to famine," Souleles said. "According to this, people should borrow some money before receiving the refund in order to increase a little their consumption. Then they should save much of the refund after receiving it in order to make the higher level of consumption last further into the future. Instead people binge as soon as they get the refund."

These results help explain how the president of the United States can make the economy look good near election time just by tweaking income tax policy.

"The best example was the Bush administration, " Souleles said. "Bush only changed the timing of when taxes were withheld, not how much was withheld. Yet according to these results spending probably went up in reaction to Bush's policy."

The talk was part of the Fall Public Policy Seminar series. The next three seminars, addressing crime policy, will be October 3, 10 and 17, noon to 1:15 p.m. at 2034 Steinberg-Dietrich Hall.

Return to Compass Features for October 1, 1996