Where Does it Go? Spending by the Financially Constrained

by Shawn A. Cole, John Thompson & Peter Tufano

Overview — Despite widespread interest by academics, businesspeople, and policymakers, much is unknown about the financial behavior of low-income individuals, particularly those who rarely or ever use banks. Do credit constrained consumers spend money more quickly than less constrained consumers? Do they spend the money in different manners (card-based merchant transactions versus cash ATM withdrawals)? Do credit constrained consumers have different spending patterns than the less constrained—do they buy different goods and services? This working paper provides preliminary data on spending patterns by over 1.5 million refund recipients, all of whom used either a loan or a settlement product to receive refund money faster than the IRS processes would have otherwise allowed. The results should inform the view of policymakers, financial service professionals, scholars, and consumer advocates. Key concepts include:

The conclusion that a material fraction of funds was used to pay for necessities suggests that the federal Earned Income Tax Credit program is central to the lives of the poor.
Loans tended to be used to obtain necessities, especially funds spent in the first few days of the loans.
Consumer advocates who seek to ban settlement products should consider how a ban would affect households' ability to smooth consumption. Similarly, businesses that are pricing and marketing these products should be mindful that the products are not a luxury for the users.
These findings document the fairly rapid speed of spending of refunds, which may help policymakers think about the economic stimulus impact of tax refunds and rebates.

Author Abstract

In this paper, we analyze the spending decisions of over 1.5 million Americans who vary in their degree of revealed credit constraints. Specifically, we analyze how these Americans spend their income tax refunds, using transaction-level data from a stored-value card product. Card-holders may choose among several tax settlement and loan options, effectively receiving cash as much as 90 days earlier than would have been possible without a settlement product. Those selecting earlier settlement options pay higher fees and interest, therefore revealing the level of credit constraints or impatience. We find that 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.