We’re in the Money but What Will We Do with It?

With unusual speed, the IRS sent out the first tranche of $100 billion in recovery rebates last Monday. It took Congress and the President less than a month to enact the Economic Stimulus Act of 2008 and then just 62 days for the IRS to begin getting the money into people's hands. The question now is what will they do with the windfall, which for couples will be as much as $1,200 plus $300 per child. The answer may disappoint those who are hoping a new burst of consumer spending will give the lagging economy a needed boost.
 
History and poll responses provide some guidance.  A 2003 study of the 2001 tax rebates  estimated that nearly half of recipients used their rebates to pay down debt and another third saved theirs.  Only about one-fifth of the rebates went for the immediate consumption policy makers had hoped would help boost a lagging economy.  A 2007 analysis of the 2001 rebates based on the use of credit cards found that although many recipients initially used their rebates to pay down their credit card debts, over the next nine months their total spending rose by an amount roughly equal to 40 percent of their rebates.  Rebates appear to raise consumption but much of the effect isn’t felt for many months.

What will happen now?  Consumer debt is much higher than it was seven years ago and polls show angst about the economy and the direction it’s headed.  Both of those conditions suggest that recipients will use more of their rebates to pay down debt than they did in 2001.  The most recent surveys show consumer plans that closely match spending patterns found in the 2003 study: most people plan to save or, equivalently, pay down debt. Just one in five expects to spend more.  Only time will tell, but consumer caution could well blunt the hoped-for expansionary boost to our flagging economy