Why Taxing the Wealthy and Giving to the Poor Makes Sense

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I apologize for the irregular posting, I’ve had a lot come up lately. But amidst all the personal drama I figured I would share an insight, a reminder for many of you.

We should be taxing the wealthy and giving money to the poor.

It is simple economics, in fact I was just explaining it to an Undergrad I’m helping in Macro 201 (intro). To increase the GDP when the economy is in recession the government should do one of two things on the fiscal side: Tax less and spend more. — Shocker. This is the basic tenet that myself and many like me have been preaching in the face of the other talking heads.

When we are off our long-run potential output, fiscal expansionary policy helps move the economy back. But the intensity of these policies is largely determinant on the multiplier that each additional dollar in taxes, transfers or spending exhibit in the economy.

If you’re not up on multipliers, essentially it relates the amount spent per dollar received and its relation to how that money continues to be used in the economy. In the end, the one dollar you give to someone ends up having a net effect different from that initial one dollar based on this multiplier. So, a high multiplier means more money gets fed into the system.

Now multipliers are positively related to a persons propensity to consume the dollar they received, either directly through spending (spending multiplier) or indirectly (through taxes and transfer payments). So needless to say, giving money to people who are more likely to spend it is a better solution than giving it blindly. Further, because people don’t spend every dollar the receive (although, it can be pretty close) it is almost always the case that the spending multiplier (1/(1-MPC)) is greater than the tax multiplier (MPC/MPS) (MPC = Marginal Propensity to Consume, MPS = Marginal Propensity to Save).

Under this condition, to stimulate the economy it is better for the government to engage in direct spending (infrastructure, R&D… whatever) than to give tax cuts. But, perhaps for social welfare this is not the case (people will spend their money better than the government will.) If this is agreed upon than the best system is taxing the wealthy and spending it on the poor.

Before you call the socialist police, im not saying that we should discourage hard work by taxing the wealthy some absorbent rate and give it to those who don’t want to work for it. Not at all, but at the margins the case can be easily made that increasing taxes on the wealthy and giving to the poor is more aggressive expansionary policy, and at least temporarily would be the optimal solution if you don’t want a 100% spending forward plan. Further, because the effect to dollar is larger the government would have to spend less money to move us out of our slump – it is budget positive from that perspective.

The reason? Simple, the wealthy have a lower marginal propensity to consume than the poor (MPC for rich < MPC for poor). If you give Bill Gates $1,000 dollars he will probably spend about $.01 more – he is already rich and has everything he could want, $1,000 isn’t going to make a difference. Extreme example I know, but even if you made $1 million, do you think that $1,000 impacts you much at all? You probably wouldn’t notice, and certainly wouldn’t change your spending habits.

Now imagine a college student living on ramen noodles. If you give the student an extra $1,000 dollars it will likely be spent to improve his/her welfare in some way (better food? perhaps just beer…). Because of the difference in how much of the initial $1,000 dollars is spent, the economy ‘feels’ the students $1,000 dollars much more than that of the wealthy.

The conclusion, give the students money and tax the wealthy.

5 thoughts on “Why Taxing the Wealthy and Giving to the Poor Makes Sense

  1. Reply George Mansanga Jan 10,2013 %I:%M %p

    We have been doing this for the last 40 years.. It has created more poverty as helpless irresponsible parents play the system and raise similar children who all play the system to the best of their abilities..

  2. Daniel McKay Reply Daniel McKay Jan 10,2013 %I:%M %p

    If you look at the quality of life and the introduction of social welfare systems you will see that they have been correlated. What hurts growth and increases poverty rates are an inefficient allocation of resources. And, if we are to look at the last 40 years, one should note that tax rates have fallen for the upper incomes dramatically while social “safety nets” such as pensions have also been diminished.

  3. Reply Robin Feb 6,2013 %I:%M %p

    Yes, yes, yesssssssssss!

  4. Reply Robin Feb 6,2013 %I:%M %p

    Maybe, this post could have been titled, Why taxing the wealthy and giving to the poor makes “cents”!

  5. Reply Shona Sep 1,2013 %I:%M %p

    Great post – sharing (because you said it better than I could)! :-)

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