Panel Paper: High-Frequency Spending Responses to the Earned Income Tax Credit

Thursday, November 7, 2019
I.M Pei Tower: 2nd Floor, Tower Court A (Sheraton Denver Downtown)

*Names in bold indicate Presenter

Aditya Aladangady1, Shifrah Aron-Dine2, David B. Cashin1, Wendy E. Dunn1, Laura J. Feiveson1, Paul Lengermann1, Katherine Richard3 and Claudia R. Sahm1, (1)Board of Governors of the Federal Reserve System, (2)Stanford University, (3)University of Michigan

Background: The Earned Income Tax Credit (EITC) is a refundable tax credit claimed by a large share of low- to moderate-income households. In 2017 (tax year 2016), 27 million households claimed the EITC—18 percent of all tax returns processed. Moreover, those claiming the EITC tend to be among the earliest tax filers each year, and federal income tax refunds often represent a substantial portion of their annual incomes. Starting in 2017, legislation that was part of the Protecting Americans from Tax Hikes Act (PATH) prohibited the Internal Revenue Service (IRS) from issuing any federal tax refunds claiming the EITC before February 15. As a result, EITC claimants waited longer to receive their tax refunds in 2017 than in prior years. By adding exogenous variation to the timing of household income receipt, this legislated refund delay allows us to estimate the extent to which low- and moderate- income households smooth their spending through a large, but short-lived disruption to income.

Data and Methods: We estimate spending out of federal tax refunds to recipients of the EITC in the weeks around refund issuance. Central to our study of the two-week EITC delay are new daily, state-level indexes of spending. These indexes were constructed using aggregated and anonymized credit, debit, and electronic transactions from First Data, a large payment processing company. Spending is categorized by the type of merchant where the payment transaction occurred (for example, at a restaurant or a department store) and by the location of the merchant. We use plausibly exogenous variation in the timing of refund issuance to tax filers to quantify the high-frequency spending response to the EITC refund delay.

Findings: We find EITC recipients spend 15 cents out of each refund dollar at retail stores and restaurants within two weeks of issuance, with two thirds of the spending occurring in the week of receipt. We also document an effect on non-durable consumption, as spending at grocery stores and restaurants rises with receipt of the EITC refund. Given that these refunds are large, predictable payments, our results point to excess sensitivity among low-income working families in the U.S. and suggest that alternatives to the lump sum EITC refund payments might better support consumption throughout the year.

Significance: The two-week delay in 2017 of over $40 billion in refunds—while short lived— led to a noticeable change in the timing of spending in February, suggesting limited access to liquidity for low- to moderate-income households.

Full Paper: