drupal analytics Lorenz Kueng

Assistant Professor of Finance
Kellogg School of Management
Northwestern University
2001 Sheridan Road
Evanston, IL 60208 

Email: l-kueng (at) kellogg.northwestern.edu 
Phone: (847) 491-7843 
 
 Research Interests
Macroeconomics, Public Economics
Finance, Consumption Theory
  Tax News
Identifying the Household Consumption Response to Tax Expectations using Bond Prices 
 

Although theoretical models often emphasize fiscal foresight, most empirical studies neglect the role of news, thereby underestimating the total effect of tax changes. Measuring the path of expected future tax rates from the yield spread between taxable and tax-exempt bonds, this paper finds that consumption 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 theory. 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 natural experiments, this paper shows that financial markets forecast future tax rates remarkably well in both the short and long run. Combining these market-based tax expectations with consumption data from the Consumer Expenditure Survey shows that households who have lower income, less education, or are more credit constrained respond less to news. However, the same households also respond one-for-one with large news shocks, consistent with rational inattention. Overall, the results in this paper suggest that ignoring anticipation effects biases estimates of the effect of fiscal policy downward.


Market-Based Income Tax Expectations: Anticipation of the Reagan Tax Cuts  
This video shows the evolution of the path of market-based expected tax rates from the beginning of the Carter administration in January 1977 through the first year of the Reagan administration. With a forecast horizon of 1 to 15 years, the movie shows when markets begin to anticipate the Reagan tax cuts, and how persistent they expect these tax shocks to be. The paths of expected tax rates are calculated from the term structure of yield spreads between Treasury and municipal bonds between 1/1977 and 8/1982. The time series of the actual top 1% tax rate (that is, perfect foresight tax rate) is taken from Emmanuel Saez (2004): "Reported Incomes and Marginal Tax Rates, 1960-2000: Evidence and Policy Implications", NBER Working Paper No. 10273.


Path of Expected Tax Rates During the Presidential Election of 2000: 
Estimates Using Election Probabilities from a Political Prediction Market
(click on figure to enlarge)
This figure shows the path of expected tax rates during the presidential election of 2000. These estimates are based on a regression of the market-based break-even tax rates on daily prices of a contract that pays $1 if George W. Bush wins the election, and $0 otherwise. Election probabilities are taken from the Iowa Electronic Markets.