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Household Indebtedness and the Macroeconomic Effects of Tax Changes

Sangyup Choi () and Junhyeok Shin
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Junhyeok Shin: Yonsei Univ

No 2020rwp-178, Working papers from Yonsei University, Yonsei Economics Research Institute

Abstract: This study is an attempt to investigate whether household indebtedness influences the macroeconomic effects of the U.S. tax policy. We apply a state-dependent local projection method to the exogenous tax shock series by Romer and Romer (2010) and find that a tax cut strongly stimulates the output when households are highly indebted. The expansionary effect of a tax cut in the period of high household debt is particularly significant for (i) consumption than investment; (ii) a personal income tax than a corporate income tax; (iii) during bad times than good times. These findings support household indebtedness as a measure of liquidity constraint for wealthy hand-to-mouth households at the macro-level. In response to a tax cut, households increase (decrease) labor supply when they are highly indebted (not indebted). This lack of a neoclassical wealth effect further contributes to an increase in the output. The state-dependent effects of tax policy, which influence the disposable income of the household directly, are more notable than those of the government spending policy, lending further support to the role of the household liquidity constraint channel of tax policy.

Keywords: Tax policy; Household debt; Liquidity constraints; Nonlinearity; Local projections (search for similar items in EconPapers)
JEL-codes: E32 E62 G51 H30 (search for similar items in EconPapers)
Pages: 53pages
Date: 2020-10
New Economics Papers: this item is included in nep-fdg, nep-mac and nep-pbe
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