NCPA - National Center for Policy Analysis


July 28, 2010

The current debate over whether the Bush tax-rate cuts should be renewed across the board or only for those with incomes below $200,000 is being driven by the argument that "the rich" have a lower marginal propensity to consume and, thus, smaller multipliers than the multipliers of real people, or no multiplier at all.  This is supposed to justify raising taxes on the rich, says Bob McTeer, a fellow at the National Center for Policy Analysis and former President of the Dallas Federal Reserve Bank for 14 years. 

Leaving aside whether $200,000 makes one rich and leaving aside the problems with applying the Keynesian multiplier concept economy-wide rather that to the individual, such a conclusion is fatally flawed, says McTeer: 

  • It is flawed mainly because it confuses saving with hoarding and assumes that income not spent in the first round on consumption is not spent at all, even in subsequent rounds.
  • While lower income people probably do spend a larger percentage of their marginal income on consumption in the short run, the income of higher income people usually gets spent, either directly on physical investment or indirectly on investment after financial intermediation.  

Buying stocks or bonds or depositing income in a bank or other financial intermediary doesn't mean money not spent.  It just means money not spent in the first round on consumption.  It is usually spent in later rounds on investment, says McTeer. 

If the marginal propensity to consume were 100 percent, there would be no investment, and, soon, no income, says McTeer. 

Source: Robert McTeer, "The Flawed Assumption Behind Ending The Bush Tax Cut For The Rich," Forbes, July 27, 2010. 

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