A Tax-Based Estimate of the Elasticity of Intertemporal Substitution

Jonathan Gruber ()
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Jonathan Gruber: Massachusetts Institute of Technology, Department of Economics, 50, Memorial Drive, Building E52, Room 355, Cambridge MA, 02142-1347, USA

Quarterly Journal of Finance (QJF), 2013, vol. 03, issue 01, 1-20

Abstract: One of the most important behavioral parameters in macroeconomics is the elasticity of intertemporal substitution (EIS). Starting with the seminal work of Hall (Hall, R., 1978, Stochastic Implications of the Life Cycle — Permanent Income Hypothesis: Theory and Evidence,Journal of Political Economy86, 971–987), researchers have used an Euler equation framework to estimate the EIS, relating the growth rate of consumption to the after-tax interest rate facing consumers. This large literature has, however, produced very mixed results, perhaps due to an important limitation: The impact of the interest rate on consumption or savings is identified by time-series movements in interest rates. Yet the factors that cause time-series movements in interest rates may themselves be correlated with consumption or savings decisions. I address this problem by using variation across individuals in the capital income tax rate. Conditional on observable characteristics of individuals, tax rate movements cause exogenous shifts in the after-tax interest rate. Using data on total non-durable consumption from the Consumer Expenditure Survey over two decades, I estimate a surprisingly high EIS of two. This finding is robust to a variety of specification checks.

Keywords: Savings; taxation (search for similar items in EconPapers)
Date: 2013
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Citations: View citations in EconPapers (75)

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DOI: 10.1142/S2010139213500018

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