Wednesday, August 18, 2010

Bush's tax cuts

One general question about tax cuts is, where does the marginal unit of aggregate demand come from? One argument says that you give it to the poor, as they spend most of their income. Another argument says that you give it to the rich, as they have more discretionary spending, and so control marginal aggregate demand.

Here's some thinking on that topic from Mark Zandi.
In most times, raising taxes on the wealthy by such a modest amount has had little impact on the economy. But these aren’t most times. The well-to-do appear unusually sensitive to changes in their finances, probably because their nest eggs are significantly smaller with the drop in stock and housing prices. Only the top 3 percent of households would have to pay higher taxes if the president got his way, but this rarefied group currently accounts for a fourth of consumer spending. If they pull back, even a bit, the recovery could be derailed.
Consumer spending makes up about 70% of the economy, so that 3% of households generate about 20% of total AD.

4 Comments:

Blogger Tom Hickey said...

This concerns me too. However, in the present political climate I don't see progressive Democrats voting for a blanket extension of the Bush tax cuts considering their constituencies would go ballistic over it. House progressives have already declared this.

The only way that could happen is if Republican would go along with another stimulus targeted at the bottom. That's just not going to happen. It's looking more likely that the Bush tax cuts will just lapse for everyone as both parties try to make hay over it, and that would be a disaster for demand.

11:22 AM  
Blogger JKH said...

The numbers suggest the top 3 per cent buy roughly $ 2.5 trillion of stuff annually. That kind of distribution somehow seems more shocking for consumer expenditures than it does for income. It seems staggering; hard to imagine in any detail. Particularly since the super-rich with truly extravagant spending patterns are probably only a subset of the top 1 per cent. And I would have expected the high end to make a disproportionate contribution to saving, offset by lower end dissaving, which would be a drag on the high end consumption stat, apart from other things. Is the luxury consumer products market really that massive? (e.g. GDP doesn’t include the purchase of existing houses.) It’d be interesting to see some sort of product breakdown on this if you come across anything. How much of GDP can be in the form of newly built luxury homes, private planes, yachts, and jewellery?

9:37 AM  
Blogger winterspeak said...

Excellent question, JKH.

The top 3% btw. don't earn that much, as if anything the distribution within the top is even more dramatic that the distribution across the entire curve.

I think the top 3% means $250K-$300K/yr household. You can hit that with two college educated, mid level professionals. Or a single doctor or lawyer. This family would not be able to afford a home in Manhattan or San Francisco, and would be out $30K/year in child care (20% of after tax income). I have no idea how much they save, but I can see them running through most of what they have left (after taxes) in school fees, meals out, professional cleaners, vacations, etc. They aren't hurting by any means, but if they decide to go for a "stay-cation" that's a big chunk of AD taken out very easily. Or they eat in a couple more nights a week. Or they have the cleaners come every other week, instead of every week.

A lot of what they spend is discretional, and we're not talking about yachts, private planes, or luxury homes.

TOM: I think you are correct in that the tax cuts will lapse. I'm not sure what impact it will have on demand in the near term. I hope we don't get another swoon.

10:11 AM  
Blogger Ramanan said...

Reminds me of James Galbraith's book - The Predator State. I think he works a lot on the distribution of national income.

1:53 AM  

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