Poor Spend Tax Refunds Fast on Necessities
With “stimulus” tax rebates due to be issued in the next few months, it will be interesting to see how, where and when that cash gets spent (or not). New research sheds some light on what lower income an “credit-challenged” people will do. The results are not too surprising – they are most likely to spend it on necessities such as food and gas.
According to a new working paper* from the Harvard Business School, “Despite widespread interest by academics, business people, and policy-makers, much is unknown about the financial behavior of low-income individuals, particularly the unbanked and underbanked.”
The relatively new innovation of loans based on tax returns provides a useful new source of data on these consumer types. The study’s authors use this data to examine the “the spending patterns of low and moderate income households… and focus on differences in spending as a function of consumers’ credit constraints.” The sample size was roughly 1.5 million customers of H&R Block.
unlike most earlier studies on spending of tax refunds or rebates, our transaction-level data can precisely indicate how fast and where funds are spent.
The major finding of the study: “…more credit constrained or impatient individuals spend their monies more quickly. The mix of cash and merchant transactions is similar between more and less constrained groups. Finally, the primary merchant uses of refunds are to pay for necessities (grocery stores, gas stations, etc.), and the fraction of the refund spending devoted to these necessities is higher for those with greater revealed credit constraints.”
“Together, these two items ( groceries and gas) account for 37% of all merchant expenditures. If we add necessities, utilities and health, these categories account for 53% of all merchant spending. Only “Entertainment” and “Restaurants” are clearly discretionary items, but together they comprise only 13% of merchant expenditures.”
Policy makers may be intrigued by our confirmation of earlier findings that document the fairly rapid speed of spending of refunds, which is relevant for thinking about the economic stimulus impact of tax refunds and rebates.
The Earned Income Tax Credit was vindicated by the study: “the details about how refunds are spent provide insight into the importance of the EITC program. In particular, the conclusion that a material fraction of funds are used to pay for necessities suggests that the program is central to the lives of the poor.”
Similarly, “Consumer advocates who seek to ban [tax refund loan] products should consider how a ban would affect households’ ability to consume. Similarly, businesses that are pricing and marketing these products should be mindful that the products are not a luxury for their users.”
* “Where Does it Go? Spending by the Financially Constrained” Shawn Cole and Peter Tufano, Harvard Business School; John Thompson, H&R Block.
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