JMP: State Tax and Transfer Progressivity and the Household Consumption Response to Fiscal Stimulus

Abstract

This paper investigates if tax and transfer policies of US state governments determine the household Marginal Propensity to Consume (MPC) out of economic stimulus payments. For the 2001 stimulus episode, I find that the average household MPC in states with the most regressive taxes and transfers was up to 59 cents per stimulus Dollar. In progressive states, it was not statistically different from zero. Moreover, I also find evidence that households in regressive states are less risk averse. Using a calibrated consumption-savings model, I show that preference heterogeneity explains the joint occurrence of cross-state differences in MPCs and in the progressivity of tax and transfer policies; state populations which are less risk averse have both larger consumption responses to transitory income shocks and favor less progressive policies. In comparison, progressivity differences in state tax and transfer policies alone cannot rationalize the empirical cross-state MPC variation out of economic stimulus payments.

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