Consumer response to the Reagan tax cuts

This paper uses micro data from the Consumer Expenditure Survey to estimate the response of household consumption to the second and third phases of the Reagan tax cuts. Since these phases were pre-announced, they allow for an unusually clean test of the canonical Life-Cycle/Permanent-Income model. Consumption is found to be excessively sensitive to the tax cuts, counter to the model. Liquidity constraints and other standard explanations do not appear to explain this excess sensitivity. The consumption response is larger than previously estimated for tax refunds and more concentrated in nondurables. These differences have important implications for the structure of tax changes, in particular for choosing between varying withholding rates versus varying 'lumpy' final tax payments and refunds. (C) 2002 Elsevier Science B.V. All rights reserved.