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The Impact of a Permanent Income Shock on Consumption: Evidence from Japan's 2014 VAT increase

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  • David CASHIN
  • UNAYAMA Takashi

Abstract

We test the Life Cycle/Permanent Income Hypothesis (LCPIH) using Japan's 2014 value-added tax (VAT) rate increase as a natural experiment. The VAT rate increase represents an unanticipated and proportional reduction in lifetime resources for several reasons: few goods and services are exempt from the VAT; the tax rate increase was uncompensated; it was fully passed on to households in the form of higher prices; and the VAT increase was not anticipated prior to Prime Minister Shinzo Abe's October 2013 announcement. Contrary to the excess smoothness literature, we find that consumption fell in proportion to the income shock upon announcement, implying that we cannot reject the LCPIH.

Suggested Citation

  • David CASHIN & UNAYAMA Takashi, 2016. "The Impact of a Permanent Income Shock on Consumption: Evidence from Japan's 2014 VAT increase," Discussion papers 16052, Research Institute of Economy, Trade and Industry (RIETI).
  • Handle: RePEc:eti:dpaper:16052
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    Blog mentions

    As found by EconAcademics.org, the blog aggregator for Economics research:
    1. Inflation and Fiscal Policy
      by Steve Cecchetti and Kim Schoenholtz in Money, Banking and Financial Markets on 2016-09-12 18:01:59

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    Cited by:

    1. David B. Cashin & Jamie Lenney & Byron F. Lutz & William B. Peterman, 2017. "Fiscal Policy and Aggregate Demand in the U.S. Before, During and Following the Great Recession," Finance and Economics Discussion Series 2017-061, Board of Governors of the Federal Reserve System (U.S.).
    2. David B. Cashin, 2017. "The Household Expenditure Response to a Consumption Tax Rate Increase," Finance and Economics Discussion Series 2017-035, Board of Governors of the Federal Reserve System (U.S.).

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