## Friday, March 13, 2009

### The Stimulus Plan, Pt II

The plan has a very interesting table regarding multipliers. A multiplier is an estimate of the "cumulative impact of various policy options on GDP over several quarters"

Notice that spending can have a minimum multiplier of 1 -- meaning each dollar spent adds that dollar to the national GDP total -- and a maximum multiplier of 2.5 -- meaning each dollar spent adds 2.5 dollars to total GDP. The truth is most likely in the middle somewhere.

The reason for this multiplier effect is simple. Government body buys \$1 of goods. Someone has to sell those goods to the government. In addition, someone has to make those goods which are then sold to the government. And someone has to extract the raw materials to put into those goods. In short, a purchase stimulates the entire chain of production from extraction to sale. Hence the possibility of a higher multiplier.

First, these estimates are from the Joint Committee on Taxation, whose website is here. Notice that with tax cuts the multiplier is higher for lower and middle income tax cuts than upper income tax cuts. Why? A tax cut for lower and middle income people effects a larger amount of people -- that is, there are more taxpayers in the middle income brackets than higher tax brackets. According to this table from the Tax Policy Center there were 1448 tax units in the 28% tax bracket in in 2007 compared with 73 in the 33% bracket. Basically, this is simple math.

duke-rules said...

"Hence the possibility of a higher multiplier" - any government spending will cause a minimum multiplier of 1, and usually higher than 1 as Bonddad indicates.

Tax cuts are a different animal. The multiplier expands only on money being spent. That's why government 'spending' has a minimum multiplier of 1 - it gets 'spent'.

"Notice that with tax cuts the multiplier is higher for lower and middle income tax cuts than upper income tax cuts". This is more easily explained by the different 'propensities to spend' between lower and middle income folks and the folks who benefited from the Bush tax cuts. The less income you have, the more likely you are to spend most of what you have for food & housing. Hence, the more that is spent, the higher the multiplier. This situation not shared by the higher income folks. If the government gives them money they are less likely to spend it (lower propensity to spend). If they don't spend it all, their multiplier is less than 1. That's why tax cuts are an ineffective way to stimulate the economy!

Anonymous said...

Tax cuts on lower income taxpayers have a higher multiplier because they spend a larger portion of their income. In this environment, higher income taxpayers will spend a portion to buy T-bonds which adds nothing to GDP. In a rising stock environment, a portion would go into IPO's instead, which would add to GDP.

Feanen said...

The number of people affected by a tax cut won't change the multiplier. With more people affected, each person gets less money for the same total dollar value of the tax cut.

The reason that lower and middle class tax cuts have a higher multiplier than upper class tax cuts is that rich people are less likely to spend the money they get in tax cuts. If you cut taxes for someone that needs another \$50/month to keep up with their bills, they will spend the tax cut. If you cut taxes for someone who is already adding \$10k/month to their savings, they will just dump it into their savings. Savings do not generate growth, only spending can do that.

Judge William said...

Gov't 'stimulus' by all accounts should have a much lower 'multiplier'.

First of all, for every dollar gov't spends, it has to take it from another consumer - no real value is created.

In addition, gov't is a notoriously inefficient as well as slow allocator of resources - so the effects are greatly muted, versus leaving the funds in private hands.

This is why gov't stimulus programs never worked and never will. They failed for Hoover, Roosevelt, Ford, Carter, Japan in the 90's, and Bush II.

It will only stimulate/multiply bigger more wasteful government.