Although theoretical models of household behavior often emphasize fiscal foresight, empirical studies of household consumption have yet to document the role of news about tax changes. Using novel high-frequency bond data, I develop a model of the term structure of municipal yield spreads as a function of future top income tax rates and a risk premium. Testing the model using the presidential elections of 1992 and 2000 as two quasi-natural experiments shows that financial markets forecast future tax rates remarkably well in both the short and long run. Combining these market-based tax expectations with data from the Consumer Expenditure Survey, I find that spending of high-income households increases by close to 1% in response to news of a 1% increase in expected after-tax lifetime income, consistent with the basic rational-expectations life-cycle consumption theory. These findings imply that by ignoring anticipation effects, previous estimates of the total effect of a tax change could be substantially biased.
|Original language||English (US)|
|Publisher||Social Science Research Network (SSRN)|
|Number of pages||38|
|State||Published - Dec 2015|