The MPC (Marginal Propensity for Consumption) and Economic Stimulus

The other day, I saw a recent video in Khan Academy’s Microeconomics series entitled “MPC and Multiplier” which is about the Marginal Propensity for Consumption (at its most basic level: if you received a windfall of $100 how much would of it would you spend). It’s only a few minutes, and I would suggest watching it before reading the rest of the post:

Ok, with that out of the way, I have a few ideas that I would like to put out there. IANAE (I am not an economist) and I welcome any critique of these ideas, but they seem pretty sensible.

Premise: The utility of a dollar decreases with accumulation

I propose first the idea of the diminishing marginal utility of the dollar. This is by no means new, I just want to establish it as a basis for my argument.

The more dollars you possess / earn, the less value each additional dollar brings to you. If you are flat-broke, a single dollar means a small bit of sustenance. If you are a low-wage worker, it means one step closer to paying a bill or buying a meal. If you are middle-class (mid-five-figures to low-six-figures), it becomes something that you at least observe coming in and going out. But beyond that, it presents less and less utility.

For example, a person that earns $1M per year (or more — a little over 300,000 people in the US right now) earns a minimum of $480 / hour before taxes. Or just shy of $4000 per day. About $83,000 per month, pre-tax. One additional dollar is such a small fraction of their income it may not even be worth their time to spend a second to pick one up. (If you earn $7.5M or more annually, it isn’t)

Corollary: A person who finds greater utility in a dollar is likely to spend more of it.

The Fair Tax Act proposed an alternate system of taxation that includes a “Family Consumption Allowance“. I don’t have an opinion about the Fair Tax Act here, but the “Family Consumption Allowance” is a great illustration of this point: Starting at the first dollar you earn, there is a (fuzzy) threshold where every nearly all dollars up to that point must be consumed just in order to pay for the very basic things; roof, food, utilities, etc. Most people call this “living paycheck to paycheck.”

If you provide additional money to people at these income brackets, that money will go directly back into the economy, as those people spend it on the various things they need to purchase. This money will be biased towards survival goods, utilities, groceries and rents, but it’s still flowing forwards. Since the vendors of those products are more likely to be other people of similar economic stature (or be an employer of people of similar economic stature), this spent money has a net positive effect on their local economies.

Therefore: Any economic stimulus should be done in a way that predominantly benefits the lower-end of the economic spectrum

I realize that, at face value, the Bush tax cuts appear to have done that. Except that they didn’t. A tax-cut given of even percentage across all taxpayers will give a nominal amount that is significantly disproportionate to the wealthier strata. (5% of $10,000 is $500, 5% of of $100,000 is $5,000, and 5% of $1,000,000 is $50,000).

My armchair-quarterbacking suggestion is to employ the Family Consumption Allowance (or something similar) for all Americans, of all economic strata. Basing it on poverty-line or actual consumption data seems like a good start (see the table in that last wikipedia link), although I think the idea of the government sending out monthly checks seems a little excessive. It would be easier to simply increase the personal / family tax exemptions to the point where, for a family of four, the first ~$30k (inflation-adjusted) was tax-exempt; for all people. This will disproportionately help those at the bottom, who both need it more and will be more likely to spend it (rather than invest it). Growth is a futile venture when you can’t maintain or sustain your existing size.

Additionally, reducing consumption taxes on day-to-day purchases, such as on car fuel, could be helpful, provided that the fuel companies didn’t simply increase their prices to pocket the difference, like the airlines did recently.

Far more people benefit when money circulates in the economy, as the money is more likely to touch more people; so putting money in the hands of people that are more likely to spend it makes good econmic sense, IMHO. But as I said before, IANAE.

Thoughts? Let’s try to avoid political talking points here, yes? I am interested in discussion on this issue; and for whatever it matters, I didn’t vote Obama in 2008 and I probably won’t be in 2012.