Ricardian Equivalence and Consumption Response to Government Transfers:
Behavioral Motives Meet Savers and Spenders in the Real World
Wei-Kang Wong1
Abstract
This paper uses survey to explore to what extent different behavioral motives might
have affected real-world decision makers’ propensity to consume actual one-off
government transfers in Singapore and how the appeal of these motives might be
related to personal characteristics.
JEL Codes: D91, E21, E62, H31
Keywords: Ricardian Equivalence, Mental Accounting, Precautionary Savings,
Present Bias, Rule-of-Thumb Consumers
1
Department of Economics, National University of Singapore, AS2, 1 Arts Link, Singapore 117570,
Republic of Singapore. Email: ecswong@nus.edu.sg; Phone: (65) 6516-6016; Fax: (65) 6775-2646. I
especially thank George Akerlof for encouragement, Jack Knetsch for comments, and Alan Yap for
research assistance. I also thank participants at the joint symposium of Yonsei University, Keio
University, University of Hong Kong, Fudan University and the National University of Singapore for
comments and Yu Zengyang, Chua Thiam Hao, and Kevin Khoo Hng Kiat for their assistance. As the
rule of thumb, I should be solely responsible for any remaining errors.
1. Introduction
On 17 February 2006, the Singapore government announced a number of oneoff transfers and rebates to its citizens in Financial Year 2006 under the so-called
“Progress Package,” with larger transfers to the less well-off.2 The total package
amounted to S$2.6 billion, 78% of which were distributed as cash transfers under
three different schemes.3 Following the survey studies on price stickiness (Blinder,
1994), wage stickiness (Bewley, 1998) and inflation aversion (Shiller, 1996), this
paper uses survey to empirically investigate the extent to which competing behavioral
motives might have influenced the consumption and saving decisions of real-world
decision makers with regard to these transfers.
The baseline is the motive of Ricardian equivalence: if people have rational
expectations and intend to leave positive bequest, with perfect capital market and
lump-sum taxes, their consumption should remain unchanged because these transfers
would not change their intertemporal budget constraints (Barro, 1974).4 However,
people may also save these transfers for precautionary reasons (Leland, 1968), either
because government transfers are generally associated with the expectations of greater
economic uncertainties or because saving is the norm for prudent household
budgeting when one is generally uncertain about the future.5 On the other hand,
people may spend the transfers because of liquidity or borrowing constraints
2
See http://www.mof.gov.sg/budget_2006/index.html.
The three schemes that involved cash transfers were Growth Dividends, National Service Bonus, and
Workfare Bonus. See http://www.progress.gov.sg for details on the schemes. For example, a family of
four could receive up to S$3,780 in cash under the Progress Package. The median household income in
year 2005 was S$3,830. In general, the transfers were given out on 1 May 2006. The average exchange
rate during 2006 was S$1=US$0.63.
4
Buchanan (1976) and O’Driscoll (1977) trace the idea back to David Ricardo.
5
After all, a government is more likely to give transfers in anticipation of bad times, the optimistic
rhetoric behind the transfers notwithstanding.
3
2
(Hubbard and Judd, 1986)6, non lump-sum taxes (Barsky, Mankiw and Zeldes,
1986)7, population turnover and the entry of new households8, the expectations that
the government may not need to raise future taxes to finance the transfers 9, myopia or
present-bias (Laibson, 1997)10, rule-of-thumb consumption behavior (Campbell and
Mankiw, 1989, Mankiw, 2000)11 due to mental accounting (Shefrin and Thaler,
1988)12, near rationality (Akerlof and Yellen, 1985)13 or spending norms (Akerlof,
2007).14
3. Methodology and Results
The survey first asked the respondents whether they spent the transfers. It
then summarized and presented eight standard textbook theories of Ricardian
equivalence and non-equivalence in plain English, and asked the respondents to
With the transfers, the government is effectively borrowing on the household’s behalf. If household
either cannot borrow on its own or can only borrow at a higher interest rate than the government, then
the transfers relax the household’s budget constraint, making higher consumption feasible.
7
With taxes as a function of income, a combination of government transfers today and higher taxes in
the future raises the household’s lifetime after-tax income if its future income is low, and vice versa,
thereby reducing the variance of the household’s after tax incomes and precautionary saving, thus
inducing higher consumption.
8
With population turnover and the entry of new households, some of the future tax burden will be
borne by the new households who are not alive at the time of the transfers. Thus, the transfers increase
the lifetime resources of the individuals who are currently living, thereby raising their consumption.
9
People may expect the government to cut future spending or to finance the transfers using past
accumulated surpluses. However, this last reason may be quite unique to Singapore because most
countries have accumulated debts from deficits, not surpluses.
10
Present bias is attributable to the saliency of current consumption and can lead to self-control
problem. Even if the consumers fully anticipate the future increase in tax burden and are fully aware of
their self-control problem, the consumers will still spend the transfers, because the cash transfers relax
their pre-imposed liquidity constraint (aimed at self-control). Myopia may aggravate the problem. The
myopic consumers may feel wealthier and consume more because they fail to foresee or understand the
budgetary implications of government transfers.
11
Rule-of-thumb consumers simply spend their current income.
12
Under mental accounting, incomes from different sources are treated differently, with higher
marginal propensity to consume out of cash or check receipts, and lower propensity to consume out of
planned savings and wealth.
13
Starting from optimal consumption, the utility foregone from not re-optimizing in the face of small
income or fiscal shocks is even smaller (only second-order in magnitude). Thus, even a small cognitive
cost of re-optimization may prevent fully rational utility-maximizing consumers from re-optimizing.
14
These consumption norms may arise from what the consumers think they should or should not spend,
say because of what they perceive to be prudent household financial practices.
6
3
choose the statements that best described how they felt about the transfers.15 Table 1
reports the brief statements that were actually presented to the respondents and the
respective behavioral motives tested. The respondents could, and sometimes did,
choose more than one statements.
Finally, the survey elicited the respondents’
expectations on future government taxes and spending given the transfers. The survey
was presented in hardcopy to people on the streets during late February to late March
2007, roughly one year after the Package was announced.16 All respondents were
adult citizens who did receive some cash transfers.
To investigate to what extent competing motives affected the propensity to
spend the transfers, Table 2 regresses the respondents’ self-reported spending decision
on their chosen explanations and reports the odds ratios estimated using maximum
likelihood logistic regression. The dependent variable is a dummy variable which
equals one for spender (who reported having spent the transfers or planning to do so
soon), and zero otherwise. The independent variables are eight dummy variables,
each indicating whether a particular explanation was chosen.
Being liquidity
constrained predicts spending behavior perfectly; 35 respondents chose liquidity
constraint and they were all spenders. Thus, they are dropped from the regression.
All of the estimates are statistically significant at the 10% level except the
coefficient on the bequest motive, which is also the smallest in magnitude. Three
motives reduce the probability of spending the transfers. They are (in descending
order of statistical and economic significance): precautionary saving, Ricardian
equivalence, and the bequest motive.
The effects of precautionary saving and
Ricardian equivalence are statistically significant at the 1% level and 5% level
respectively. Four motives raise the probability of spending the transfers. They are
See, for example, David Romer’s (2006) Advanced Macroeconomics for a standard textbook
treatment.
16
The actual survey form is available upon request.
15
4
(in descending order of economic significance): present bias, rule of thumb, entry of
new households, and non lump-sum taxes. The effects of present bias and rule of
thumb are both statistically significant at the 1% level, whereas the effects of entry of
new households and non lump-sum taxes are statistically significant at the 10% level
and 5% level respectively. Overall, precautionary saving, present bias, and rule of
thumb are the most economically and statistically significant motives in changing the
propensity to spend the transfers.
Table 3 regresses the respondents’ choices of explanations on their personal
characteristics and reports the odds ratios estimated using maximum likelihood
logistic regressions.
Column (1) investigates how an individual’s personal
characteristics affected his consumption decision, using as the dependent variable a
dummy variable which equals one for spender, and zero otherwise. Columns (2) to
(9) examine how personal attributes affected consumption decision through the appeal
of different motives, where the dependent variable in a particular column is a dummy
variable which equals one if a particular explanation is chosen, and zero otherwise.
The personal characteristics include a number of ordinal variables (for age group,
educational attainment, income group, dwelling type) and dummy variables (for
female, married persons, Ricardian expectations – the expectations that taxes would
be higher because of the transfers – and the clueless regarding the budgetary
implications of transfers).17
The evidence in Column (1) suggests that older, more educated, higher income
individuals dwelling in more expensive residence were less likely to spend the
transfers. The age effect is only marginally statistically significant at the 10% level,
whereas education, income and dwelling type are statistically significant at the 5%
The clueless refers to those who chose “don’t know” when asked about their budgetary expectations
(on future taxes and government spending).
17
5
level. Female and married persons were more likely to spend the transfers but the
effects are not statistically significant at the conventional levels. Both budgetary
expectations reduced the probability of spending the transfers but the effects are not
statistically significant at the conventional levels.
It turns out that personal attributes were correlated with the appeal of different
motives. Older respondents were more likely to choose Ricardian equivalence and
non lump-sum taxes (both effects are statistically significant at the 10% level), but
they were less likely to choose rule of thumb (the effect is statistically significant at
the 1% level). The stronger appeal of Ricardian equivalence and the weaker appeal of
rule of thumb discouraged spending, whereas the stronger appeal of non lump-sum
taxes encouraged spending.18 The net effect is that older respondents were less likely
to spend the transfers, as noted above.
There is little evidence that men and women differed significantly in their
spending decisions or motivations except that women seemed marginally less likely to
choose the entry of new households to explain their behavior and the effect is
marginally statistically significant at the 10% level. Naturally, married persons were
much more likely to choose the bequest motive as they were more likely to have
children. They were also less likely to be liquidity constrained. Both effects are
statistically significant at the 5% level.
The more educated were much less likely to be liquidity constrained and the
effect is statistically significant at the 1% level. Somewhat surprisingly, general
educational attainment had no statistically significant effect on the popularity of
Ricardian equivalence, rule of thumb, or present bias. Income level also had no
statistically significant effect on the popularity of any of the explanations.
18
They thought that when the government finally increased the taxes to finance the transfers, their tax
burden would be lower because they would be earning and spending less.
6
Nevertheless, the largest effect appeared to work through non lump-sum taxes: higher
income individuals were less likely to think that their tax burden would be lower in
the future – they did not think that they would be earning or spending less when taxes
were raised to finance the transfers. Respondents in more expensive dwellings were
presumably wealthier.
They were more likely to choose present bias (which
encouraged spending and the effect is only marginally statistically significant at the
10% level) and less likely to choose rule of thumb (which discouraged spending and
the effect is highly statistically significant at the 1% level). The net effect is that they
were less likely to spend the transfers.
Respondents with the Ricardian expectations were naturally more likely to
choose Ricardian equivalence and the effect is statistically significant at the 5% level.
However, they were also more likely to choose present bias and the effect is
statistically significant at the 10% level.
The net effect is that they were not
significantly more likely to save the transfers.
In comparison, those who were
completely clueless about the budgetary implications of the transfers were not
inclined to choose any particular explanation.
Finally, despite its overall popularity, the appeal of precautionary saving was
not significantly related to any of the personal characteristics included, suggesting that
it might have been a general motivation that transcended personal characteristics.
3. Future Research
The relative appeal of different motives may be quite sensitive to the specific
context and background of government policy. Investigating the robustness of results
reported here to other episodes of government transfers or tax cuts is a natural next
step on the research agenda.
7
References
Akerlof, G.A., 2007, The missing motivation in macroeconomics, American
Economic Review 97, 5-36.
Akerlof, G.A. and J.L. Yellen, 1985, A near-rational model of the business cycle, with
wage and price inertia, Quarterly Journal of Economics 100 (Supplement), 823-838.
Barro, R.J., 1974, Are government bonds net wealth? Journal of Political Economy
82, 1095-1117.
Barsky, R.B., N.G. Mankiw and S.F. Zeldes, 1986, Ricardian consumers with
Keynesian Propensities, American Economic Review 76, 676–689.
Bewley, T.F., 1998, Why not cut pay? European Economic Review 42, 459-490.
Blinder, A., 1994, On sticky prices: academic theories meet the real world, in N.G.
Mankiw, Ed., Monetary Policy (University of Chicago Press), 117-150.
Buchanan, J.M., 1976, Barro on the Ricardian equivalence, Journal of Political
Economy 84, 337–342.
Campbell, J.Y. and N.G. Mankiw, 1989, Consumption, income and interest rates:
reinterpreting the time series evidence, NBER Macroeconomics Annual, 185-216.
Hubbard, G.R. and K.L. Judd, 1986, Liquidity constraints, fiscal policy and
consumption, Brooking Papers of Economic Activity 1, 1-60.
Laibson, D., 1997, Golden eggs and hyperbolic discounting, Quarterly Journal of
Economics 112, 443–47.
Leland, H.E., 1968, Saving and uncertainty: the precautionary demand for saving,
Quarterly Journal of Economics 82, 465-473.
Mankiw, N.G., 2000, The savers-spenders theory of fiscal policy, American
Economic Review 90, 120-125.
O'Driscoll, G.P., 1977, The Ricardian nonequivalence theorem, Journal of Political
Economy 85, 207-210.
Romer, D., 2006, Advanced Macroeconomics (McGraw-Hill/Irwin).
Shefrin, H.M and R.H. Thaler, 1988, The behavioral life-cycle hypothesis, Economic
Inquiry 26, 609-643.
Shiller, R., 1996, Why do people dislike inflation? in C. Romer and D. Romer, Eds.,
Reducing Inflation: Motivation and Strategy (National Bureau of Economic Research
and University of Chicago Press).
8
Table 1: Behavioral Motives Tested and Brief Descriptions Presented to the
Respondents
Underlying
Theory
Ricardian
Equivalence
Bequest Motive
Liquidity
Constraints
Entry of New
Households
Non Lump-sum
Taxes
Precautionary
Savings
Present-Bias
Rule of Thumb
Others
Brief Description Presented to the Respondents
I will probably have to pay more taxes in the future because of the
Progress Package. So I saved it for the future.
The future generations will probably have to pay more taxes
because of the Progress Package. But not for me. But I am
worried for my sons and daughters. So I saved it for them.
I spent it because I have already spent all my money. If I could
borrow some money, I would have borrowed it and spent it.
The future generations will probably have to pay more taxes
because of the Progress Package. But not for me. So I do not
worry about it and I spent it.
Other people may have to pay more taxes in the future because of
the Progress Package. But not for me. My tax burden will be
lower in the future because I will be earning less or spending less
when that happens.19
I do not know what my taxes will be in the future. But with so
much uncertainty, I saved it for the rainy days.
I will probably have to pay more taxes in the future because of the
Progress Package. But I do not worry about the future. I spent it
while I could.
I do not know what my taxes will be in the future. As a general
rule, I just spend whatever I receive in cash or in check, like the
Progress Package. But I try not to touch my savings.
Others
19
In Singapore, two main tax burdens on the individuals are income tax (which depends on income)
and the Goods and Services Tax (i.e., GST, which depends on expenditure).
9
Table 2: Logistic Regression of Spending Decision on Behavioral Motives
Dummy for Ricardian Equivalence
Dummy for Bequest Motive
Dummy for Entry of New Households
Dummy for Non Lump-sum Taxes
Dummy for Precautionary Saving
Dummy for Present Bias
Dummy for Rule-of-Thumb
N
Dummy for Spender
0.44
[0.14]**
0.6
[0.25]
8.7
[9.81]*
5.89
[4.26]**
0.31
[0.09]***
30.23
[32.68]***
14.39
[6.80]***
460
Notes: The dummy for liquidity constraint and the 35 respondents who chose liquidity
constraint are dropped because they predict spending behavior perfectly.
This table reports the odds ratios. Robust standard errors are in the brackets. *
Significant at 10%; ** Significant at 5%; *** Significant at 1%.
Table 3: Logistic Regression of Spending Decision and Motivations on Individual Characteristics
Dependent Variable = Dummy for Spending Decision and Motivations
[1]
Spender
Age Group
Female Dummy
Educational Attainment
Income Group
Married Dummy
Residential Type
Ricardian Exp. Dummy
Clueless Exp. Dummy
N
0.89
[0.06]*
1.27
[0.29]
0.83
[0.07]**
0.86
[0.06]**
1.04
[0.27]
0.86
[0.06]**
0.69
[0.22]
0.62
[0.23]
469
[2]
Ricardian
Equivalence
1.15
[0.09]*
0.69
[0.18]
1.11
[0.11]
1.02
[0.09]
0.62
[0.20]
1.01
[0.08]
2.59
[1.00]**
1.46
[0.69]
469
[3]
Bequest
Motive
1.18
[0.13]
0.54
[0.21]
1.03
[0.15]
1.05
[0.12]
3.55
[1.81]**
0.85
[0.11]
2.72
[1.69]
1.41
[1.09]
469
[4]
Liquidity
Constraint
0.96
[0.12]
0.92
[0.36]
0.66
[0.10]***
0.91
[0.11]
0.3
[0.17]**
0.86
[0.12]
0.63
[0.29]
0.64
[0.36]
469
[5]
Entry of New
Households
1.14
[0.10]
0.57
[0.18]*
1
[0.12]
0.96
[0.10]
1.22
[0.41]
0.84
[0.10]
0.85
[0.33]
0.64
[0.32]
469
[6]
Non Lumpsum Taxes
1.23
[0.13]*
1.32
[0.48]
0.9
[0.13]
0.81
[0.11]
0.68
[0.33]
0.89
[0.11]
0.63
[0.27]
0.62
[0.35]
469
Notes:
1. This table reports the odds ratios.
2. Robust standard errors are in the brackets. * Significant at 10%; ** Significant at 5%; *** Significant at 1%.
[7]
Precautionary
Saving
0.99
[0.06]
1.26
[0.26]
1.11
[0.08]
0.99
[0.06]
1.02
[0.26]
1.04
[0.07]
0.99
[0.27]
0.96
[0.32]
469
[8]
Present
Bias
1.03
[0.08]
1.02
[0.24]
1.07
[0.11]
0.96
[0.08]
0.62
[0.20]
1.12
[0.08]*
1.92
[0.68]*
1.17
[0.52]
469
[9]
Rule-ofThumb
0.81
[0.06]***
1.04
[0.21]
1.04
[0.08]
0.99
[0.07]
1.5
[0.38]
0.83
[0.06]***
1.09
[0.30]
1.6
[0.53]
469