Lars Perner, Ph.D.
Assistant Professor of Clinical Marketing
Department of Marketing
Marshall School of Business
University of Southern California
Los Angeles, CA 90089-0443, USA
(213) 740-7127
Cell: (213) 304-1726

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The tax rebates that will be released this year have been targeted primarily at lower to middle income consumers.  These consumers are likely to have a higher “marginal propensity to consume”—that is, they are likely to spend, rather than save, a higher percentage of any additional income they receive.  This type of tax rebate, then, is likely to get a greater “bang for the buck” than rebates aimed at higher income consumers.

Research suggests that people will often feel more free to spend, rather than save, this type of “windfall” money than they would be if it had been received as an anticipated raise at work.  It is money that had not been counted on, and it is therefore seen as something more “appropriate” to spend. Because money is "fungible"--that is, money is worth the same and can be spent on the same things regardless of its source--this behavior is not entirely rational. However, a great deal of research in the field of "mental accounting" shows that the source of money and the way it is presented have a large impact on the decisions on consumers on what to do with it.

In the coming months, many advertisers will probably come up with numerous “suggestions” as to how consumers should spend this money.  A household with two spouses plus two children are potentially eligible to receive 2*$600+2*300=$1,800, which is enough to buy one or more “big ticket” items such as a large flat screen TV or a computer.  Alternatively, consumers may spend this money “piece meal,” eating out at restaurants more or buying several small things.

Because food and gasoline prices have gone up dramatically over the last several years, an increasing number of low to middle income consumers are facing a considerable budget “crunch,” especially at the end of the month.  Wal-Mart, in the early 2000s, initially seemed to benefit from the declining economy as consumes switched many of their purchases to lower cost outlets.  Now, however, many consumers are having trouble making ends meet even at lower price stores and many have, as a result, reduced their purchases.  The tax rebate may allow many of these consumers to buy some of these things that they would otherwise not have been able to buy.  For such consumers, then, there would not necessarily be any big new purchases; rather, the effect would be to reduce the decline in earlier spending.  Recently, food prices have increased dramatically.  This occurs both because the cost of production goes up with the cost of energy and because a number of agricultural crops now become more valuable when they are “diverted” to making fuels.  When corn and other commodities are converted into gas substitutes, the value of substitutable other commodities in turn face increased demand, resulting in a higher market price.

There may also be some consumers who may actually save their rebate money rather than spending it. Many will choose to do this in large part based on the fear that they may lose their jobs or opportunities to work overtime in the future.  This type of saving has been a problem that has limited the effectiveness of this type of stimulus measure in Japan’s economy which experienced a significant downturn during many of the last ten years. Rather than spending much of this extra money available, consumers have, instead, put away the money in anticipation of a "rainy day." Ironically, this is likely a good statetegy for the individual family, but not so good for the national economy.

One potential problem with many big ticket purchases is that many electronic products these days are imported from low wage cost countries such as China.  When imported products are sold, the net contribution to the U.S. economy is limited to the “value added” component of distribution in the U.S.  That is, such purchases may increase retail and distribution employment in the U.S. but not manufacturing employment.

Part of the effectiveness of any stimulus measure such as a tax rebate is the so-called “multiplier” effect whereby money is re-spent as those who sell—and their employees—in turn spend part of their earnings.  If consumers patronize restaurants, for example, their employees will likely work longer hours and receive greater tips, enabling these employees to buy more which, in turn, spurs on the cycle.  Restaurant owners may decide to expand their facilities, in turn creating jobs for people who, in turn, spend their money elsewhere.

April 9, 2008