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Tax Cuts for the Wealthy Will Not Stimulate the Economy, Government Spending on Infrastructure Will

Demand needs to increase for the economy to return to full employment. Businesses hire people when demand warrants it. Different economic policies can be more or less effective in stimulating demand. In the ongoing debate over economic policies, the question we should be asking is which policies give the most bang for the buck in terms of providing the economic demand needed for recovery.

There are two main ways that policies affect demand. The first is direct demand from government when it purchases goods and services through contracts or hires labor directly. The second is indirect demand from providing income to people, such as through tax cuts, who will then eventually spend it.

For the latter case of providing income to people, the level of stimulative effect depends on the personal circumstances of the people in question. Generally speaking, the lower a person's income, the greater the percentage of that income they will spend quickly. People who previously had no income will quickly spend a high percentage of any new income they receive. People with high incomes will spend much less of any new income they receive, especially the wealthiest who are already buying what they want.

So for getting the most bang for the buck in creating demand, and thus jobs, we have three broad categories of government policy options:

1) Direct government purchases or direct government hiring gives the biggest bang for the buck. Labor gets hired to fulfill contracts, and those hired employees now have incomes that they can spend. In addition, those new hires also will require materials, equipment, etc. such as an office to work in, a computer, a bulldozer, asphalt to pave roads, and so on. Each of these purchases creates additional demand for labor in order to produce them.

2) Tax breaks or benefits for low-income earners is the second most efficient policy option for creating demand and jobs. As I mentioned, low-income earners spend the greatest percentage of any additional income they receive. So payroll tax cuts, unemployment compensation, and tax credits targeted at low-income earners fit into this category.

3) Tax breaks or deductions for high-income earners is the least efficient stimulus policy. High-income earners spend the smallest percentage of their incomes because they have the least marginal benefit from spending. In other words, they have more of what they need and want already.

Now, it is true that the economy benefits from each of these policies, and we could have them all if we didn't care about the deficit. But if we admit that there is a limit to how much deficit we are willing to take on (or we'd like to maximize economic growth with minimal deficit), then we must pick and choose.

In that case, the answer is clear that the first thing that should be taken off the table is tax breaks for the wealthy. Instead, the economy would be better served by direct government demand (such as infrastructure projects) and help to low-income earners (such as through low-income tax cuts).

Photo Credit: Wikimedia Commons

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