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Rational Illiquidity and Consumption: Theory and Evidence from Income Tax Withholding and Refunds

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  • Michael Gelman
  • Shachar Kariv
  • Matthew D. Shapiro
  • Dan Silverman

Abstract

Low liquidity and a high marginal propensity to consume are tightly linked. This paper analyzes this link in the context of income tax withholding and refunds. A theory of rational cash management with income uncertainty endogenizes the relationship between illiquidity and the marginal propensity to consume, and can explain the finding that households tend to spend tax refunds as if they valued liquidity, yet do not act to increase liquidity by reducing their withholding. The theory is supported by individual-level evidence based on financial account records, including a positive correlation between the size of tax refunds and the marginal propensity to consume out of those refunds.

Suggested Citation

  • Michael Gelman & Shachar Kariv & Matthew D. Shapiro & Dan Silverman, 2022. "Rational Illiquidity and Consumption: Theory and Evidence from Income Tax Withholding and Refunds," American Economic Review, American Economic Association, vol. 112(9), pages 2959-2991, September.
    • Handle: RePEc:aea:aecrev:v:112:y:2022:i:9:p:2959-91
    DOI: 10.1257/aer.20191385
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    Cited by:

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    3. Vihriälä, Erkki, 2023. "Self-imposed liquidity constraints via voluntary debt repayment," Journal of Financial Economics, Elsevier, vol. 150(2).
    4. Qiongzhi Liu & Yifeng Xia, 2023. "The Energy-Saving Effect of Tax Rebates: The Impact of Tax Refunds on Corporate Total Factor Energy Productivity," Energies, MDPI, vol. 16(23), pages 1-19, November.
    5. Sydnee Caldwell & Scott Nelson & Daniel C. Waldinger, 2021. "Tax Refund Uncertainty: Evidence and Welfare Implications," Working Papers 2021-18, Becker Friedman Institute for Research In Economics.

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    More about this item

    JEL classification:

    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • G51 - Financial Economics - - Household Finance - - - Household Savings, Borrowing, Debt, and Wealth
    • H24 - Public Economics - - Taxation, Subsidies, and Revenue - - - Personal Income and Other Nonbusiness Taxes and Subsidies
    • H31 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - Household

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