CONSUMPTION TAX CUTS IN A RECESSION

I study the effectiveness of temporary cuts to consumption tax rates as fiscal stimulus instruments during recessions using a structural life-cycle model with multiple consumption categories. I find tax elasticities of 0.4 for nondurable luxuries and of 10.5 for durables. I show that the tax cut on nondurables has an intratemporal substitution effect, whereas the tax cut on durables acts through an intertemporal substitution mechanism that is stronger for high-income, liquidity-unconstrained, and younger households. This mechanism is amplified in less persistent recessions and dampened in absence of recessions due to durables' partial irreversibility and precautionary saving motives.