A Tax-Based Estimate of the Elasticity of Intertemporal Substitution

Jonathan Gruber ()

No 11945, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: One of the most important behavioral parameters in macroeconomics is the elasticity of intertemporal substitution (EIS). Starting with the seminal work of Hall (1978), 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 2. This finding is robust to a variety of specification checks.

JEL-codes: H2 E2 E6 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-mac and nep-pbe
Date: 2006-01
Note: EFG PE
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