Friday, December 2, 2011

The Balanced Budget Multiplier is Not Negative

Senate Republicans have a condition for supporting the continued payroll tax holiday:

Senate Republican leaders introduced a bill that would keep the payroll tax rate at its current level for another year. The cost is roughly $120 billion. Senate Republicans would offset most of the cost by freezing the pay of federal employees through 2015 and gradually reducing the federal work force by 10 percent.

The marginal propensity to consume for reductions in payroll taxes maybe be high but it is still less than unity. So if we reduce government purchases by the same amount as reduce payroll taxes – this proposal would be contractionary. I guess the good news here is that some of the reduction in government purchases would be deferred.

I guess in a world of PAYGO, however, we should ask how the Democrats propose to offset the loss in payroll taxes revenues:

Senate Democratic leaders want a deeper temporary reduction in Social Security payroll taxes. They would provide payroll tax relief to employers as well as employees. And they would offset the cost with a 3.25 percent surtax on modified adjusted gross income in excess of $1 million.

In other words, raise taxes on households who are not liquidity constrained which means if there is anything left to Barro-Ricardian equivalence, perhaps the marginal propensity to consume for changes in taxes on the very well to do is less than the marginal propensity to consume for reductions in payroll taxes. So if the goal is to increase aggregate demand – then the Senate Republican idea is awful whereas the Senate Democrat idea makes sense.


Paul Fagan said...

The balanced budget multiplier is one. See R.G.D. Allen, Macro-Economic Theory, A Mathematical Treatment 1967, Section 8.2, page 140 : "a balanced increase in expenditure and taxation by the government serves to raise income by just the amount of the increase and no more."

marmico said...

Are the Dems math challenged?

A 3.25% "millionaire income surtax" would raise less than a quarter of the revenues needed to offset an extension of the existing payroll tax cut, let alone incremental additions.

3.25% surtax x $725 billion "millionaire AGI" = $24 billion revenues

Alan said...

If the top 1% saves 25% of their income and the working class saves 5%, a transfer from one to the other does not result in unity, at least in the Algebra. (Which is a kind of mathematics.) There are leakages to pay down debt and so on, but to say it is one is nonsense.

That it survives after the experiment of the last ten years is really remarkable. Of course, it would be better to tax and hire people rather than tax and give everybody 2% more for discretionaries.

Anandi Sharan said...

Republicans as well as Democrats are challenged in so many ways one ca hardly bear to follow the discussions: I know you understand carbon permits, so you also understand political economy: nationalism is being protected by Jonathan Pershing and Todd Stern in Durban "having a conversation" about not doing anything. What is most depressing is that governments? Developed countries? Banks? Who? prefers to die with the religion of market capitalism or indeed socialism on their lips rather than in full consciousness of earth logic. True. we cannot do anything about it anymore. But why are people not willing at least to be conscious of what's going on?

Jack said...

So riddle me this. If FICA is legislatively directed to pay Social Security benefits after first winding through the Trust Fund, and if there is a surtax on one's income tax, a tax which is dedicated to flow into Treasury for the purpose of paying general budget expenses. Then how does one offset the other? A reduction of FICA revenue may put a strain on the Social Security system by reducing Trust Fund growth and/or principal. A surtax on the income tax can only offset the deficit of the general budget. It's time for politicians and economists alike to stop confusing these two funding streams that are legislatively intended and required to pay different categories of expenses.