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It’s the Multipliers, Stupid!

This is about one very simple way to tell the difference between big and little when reading usual panic articles about economic matters like “fiscal cliffs,” “sequesters,” “out-of-control deficits,” and “crushing mountains of debt.”

A little bit of arithmetic. An austerity (a.k.a. deficit-reduction) involves various tax hikes and spending cuts, but these hikes and cuts don’t always work as expected because they affect the economy, i.e., the GDP. To tell the GDP impact of eacand we simply tally up their sizes (in dollars per year) to determine how much the deficit will be cut. But, that often doesn’t work out each hike/cut will cut the GDP along with the deficit. To predict the GDP impact of a tax hike or a spending cut, we have multiply its size in dollars-per-year by its “multiplier.” Here, in order of size, are the multiplier that Mark Zandi gave Congress in 2008 to compute stimulus effects but they work equally well in both directions:

  • Accelerated Depreciation 0.27
  • Make Bush Income Tax Cuts Permanent 0.29
  • Cut Corporate Tax Rate 0.30
  • Make Dividend and Capital Gains Tax Cuts Permanent 0.37
  • Extend Alternative Minimum Tax Patch 0.46
  • =================separator=====================
  • Nonrefundable Lump-Sum Tax Rebate 1.02
  • Across the Board Tax Cut 1.03
  • Refundable Lump-Sum Tax Rebate 1.26
  • Payroll Tax Holiday 1.29
  • Issue General Aid to State Governments 1.36
  • Increase Infrastructure Spending 1.59
  • Extend Unemployment Insurance Benefits 1.64
  • Temporarily Increase Food Stamps 1.73

Notice that multipliers for hikes and cuts that mostly affect the wealthy (those above the separator) are about a quarter of the size of those that mostly affect the rest of us.

Application. So, let’s apply a multiplier to understand the significance of this from a recent HuffPo article by Mark Gongloff:

The second hit to income was the reinstatement of the federal payroll tax after a long holiday. The 2 percent increase in Social Security withholding cut nearly $127 billion from income in January, according to the BEA, Goldman Sachs economists pointed out (h/t Quartz’s Matt Phillips). The bump and decline in dividend income is a wash. The payroll-tax cut is going to be harder to shake off, leaving Americans with smaller paychecks for the rest of the year.

The higher payroll tax, along with the sequester budget cuts that will start to kick in on Friday, and other lingering effects of the “fiscal cliff” that loomed at the start of the year, will cut economic growth this year by 1.5 percent.

So, the immediate question is: how much of that prediction of a 1.5% cut to economic growth is due to ending the payroll tax holiday and how much is due the rest of the stuff, i.e., the sequester and the rest of the fiscal-cliff stuff? So we take that $127 billion per year payroll tax hike and we multiply it by the 1.29 multiplier that Mark Zandi gave for “payroll tax holiday,” and we get roughly $164 billion dollars per year, which is roughly 1% of our 16 trillion GDP.

So, two thirds of that predicted 1.5% cut to the GDP is due to ending the payroll tax holiday in January as part of the package to avoid the “fiscal cliff.” Which means that the sequester and ending the Bush tax cuts for the wealthy are predicted to have comparatively little effect on the economy, i.e., they and the other fiscal-cliff stuff make up only one third of the predicted drop in GDP.

Conclusion. Please compare the above to the shrill headlines that we got about the fiscal cliff and we are now getting about the sequester, and note that ending the payroll tax holiday, which got relatively little notice at the time, accounts for twice as much of that predicted 1.5% cut to the GDP as all the rest of these factors combined. The lessons are that:

  • The media don’t report the difference between big and little in economic matters.
  • Cuts and hikes that mostly affect the wealthy get major coverage but do not have much impact on the GDP.
  • Cuts and hikes that mostly affect the rest of us don’t get so much coverage but have about four times as much “bang for the buck,” whether they are in a positive or a negative direction.
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