海角大神

Catching up on some reading this week, and had this few-days-old pointed out to me. Dylan asks if the conventional economic wisdom on the 鈥渕arginal propensity to consume鈥� of richer vs. poorer people (that it鈥檚 higher for the poor mainly because they are too constrained and can鈥檛 afford to save) is really true. He points to a couple empirical studies based on the lump-sum-type rebate/refundable credit portions of the 2001 and 2003 tax cuts that suggest that the higher-income households were more inclined to spend their tax cuts than the lower-income ones were.

If these studies reflect today鈥檚 reality about how rich vs. poor would spend extra money, then this would weaken the argument that we should let the tax cuts for the rich go ahead and expire because they wouldn鈥檛 provide effective stimulus compared with tax cuts for lower- and middle-income households (and especially compared to other forms of deficit-financed stimulus).

But I have a couple of problems with leaping to such conclusions based on these earlier studies. First, the highest-income categories in these studies are much broader than the definition of 鈥渞ich鈥� being used in the debate about the Bush tax cuts鈥搕he latter being confined to households with incomes above $250,000. One thing I suspect is that households with income above $75,000 or $100,000 (the highest-income groups in these studies) don鈥檛 just have more than median incomes, but also have more than median household sizes. (There is a strong income effect in moving from middle- to upper-income levels in terms of the number of kids people have; not everyone can afford to have four children, trust me.) It is not at all surprising to me that if one does not control for family size, that households with higher incomes are more likely to spend most of their lump-sum, windfall-type tax cuts than households with lower incomes who also happen to be (at least I strongly suspect) smaller in size. If you compared the spending propensities of households with incomes over $250,000 with those of households with incomes between $100,000 and $250,000, holding constant family size, I bet we would see the latter has a higher propensity than the former.

Second, economic circumstances have really changed since the tax episodes in those studies. Everyone (the truly rich included) had been in high consumption mode at the time of the 2001 and 2003 tax cuts, because wealth effects (via housing values and investment portfolios) encouraged consumption and borrowing against that wealth. A little extra cash in the form of a tax rebate would be likely to be treated like an additional windfall, and hence spent. But the subprime mortgage and then general credit crisis shocked households into changing their borrowing and spending habits. Now households cannot count on the wealth in their homes or retirement funds as a reliable source of savings, so their propensities to consume out of any extra money (like from a tax cut) are going to be substantially lower now. So now it is not so much that the rich can just afford to save more than the poor, so that they will in fact save more of their tax cut. Today it is more that the rich can afford to pay down more of their debt (versus need to use for immediate consumption)鈥搃.e., reduce their 鈥渘egative saving.鈥� But reducing debt or 鈥渘egative saving鈥� is the same thing as 鈥渟aving more.鈥� So I think the rich still will tend to spend a lower fraction of any non-targeted tax cut than lower-income households and that the conventional wisdom鈥搕hat tax cuts for the rich aren鈥檛 great short-term stimulus (to boost aggregate demand)鈥搒till applies. (The issue of what types of tax cuts are the best for longer-term economic growth鈥搕o increase aggregate supply once the economy is at 鈥渇ull employment鈥濃�搃s a different matter entirely.)

------------------------------

海角大神 has assembled a diverse group of the best economy-related bloggers out there. Our guest bloggers are not employed or directed by the Monitor and the views expressed are the bloggers' own, as is responsibility for the content of their blogs. To contact us about a blogger, click here. To add or view a comment on a guest blog, please go to the blogger's own site by clicking on the link above.