Your state introduced a tax cut in the year 2007. You are interested in seeing whether this tax cut has led to increases in personal consumption within the state.
You observe the following information:
Year _______________ Consumption in your state
2002......................................330
2004......................................350
2006......................................370
2008......................................430
a. Your friend argues that the best estimate of the effect of the tax cut is an increase in consumption of 60 units, but you think that the true effect is smaller because consumption was trending upward prior to the tax cut. What do you think is a better estimate?
b. Suppose that you find information on a neighboring state that did not change its tax policy during this time period. You observe the following information in that state:
Year___________ Consumption in neighboring state
2002......................................300
2004......................................320
2006......................................340
2008......................................350
Given this information, what is your best estimate of the effect of the tax cut on consumption? What assumptions are required for that to be the right estimate of the effect of the tax cut? Explain.