The Payroll Tax Consumption Bump Was Bigger Than Expected

A cornerstone in the Federal Reserve Bank of New York

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Here’s an interesting finding from the New York Fed—the payroll tax holiday seems to have done more to goose consumption than workers themselves expected:

This paper presents new survey evidence on workers’ response to the 2011 payroll tax cuts. While workers intended to spend 10 to 18 percent of their tax-cut income, they reported actually spending 28 to 43 percent of the funds. This is higher than estimates from studies of recent tax cuts, and arguably a consequence of the design of the 2011 tax cuts. The shift to greater consumption than intended is largely unexplained by presentbias or unanticipated shocks, and is likely a consequence of mental accounting. We also use data from a complementary survey to understand the heterogeneous tax-cut response.

There’s a bit of conventional wisdom out that it’s better for a fiscal stimulus to goose consumption than to be used for savings. You can see why that might be. A recession is essentially a mismatch between people’s desire to save and firms’ desire to invest, so something that reduces desired savings would seem to help. But at the same time, when you have a recession characterized by extremely large household debt overhang, helping households reduce their debt loads might be equally valuable. So I think it’s not entirely clear whether this means the payroll tax holiday was a better-than-expected idea or a worse-than-expected one—or else, possibly, it doesn’t matter.