How to stimulate the economy: Why jobless benefits are better than tax cuts for the rich

So, there's been a lot of debate recently about the deal Obama took, which extends the tax cuts from the first Bush administration. There are a lot of details associated with Obama's proposed deal, but the big tradeoff is as follows:

Obama agrees to extend the tax cuts to the top income bracket: families that earn in excess of $250,000 annually. In exchange, he gets a 13 month extension to expiring unemployment benefits.

There are a lot of "pop" arguments about this, and the mainstream economics blogging community has covered this relatively well, I think. My intention here is to sort out some of the arguments, and explain how lots of the standard arguments don't hold a lot of water.

The basic argument grows from the argument about how much economic stimulus "bang" we get for the many, many bucks we are spending in debt in order to finance this tax cut, and the relative value of other alternatives.

If you listen to the standard dialogue that comes from the Republican right, they tell you that:

1. Deficits are really, really bad, and gosh darn it, we need to not be so damned irresponsible, and balance the budget. 
2. Tax cuts for the wealthy are good, because gosh darn it, they use their money to CREATE JOBS. 

So, the first claim is rather nakedly disingenuous. The second claim is where the meat of the issue lies. 

Generally speaking, when you cut taxes, or when you spend money, your aim is not to increase savings, your goal is to increase aggregate demand. Increased demand means that you are generating additional economic activity. In order to generate additional demand, you want the recipients of the government's largesse (remember not taxing you, OR spending money on something you sell is largesse from a government in deficit) to spend the money you give them. Once they have spent the money, then you hope the people they bought goods and services from to spend the money on something as well. It's this echoing effect of increased economic activity that makes the idea of stimulus better than a pure transfer. 

Let's focus on this for a second. If $1 is transferred from the government to an individual, and they save it, there is no increase in economic activity, just a redistribution of wealth. If, however, that individual spends the money, then there is going to be some additional economic activity. If they spend it and it gets spent again, then there is yet more economic activity. This process generates what is called a "multiplier". 

The dirty little secret of the tax cut for the nation's wealthiest is that the multipliers for giving aid to those without jobs, or otherwise those who are very poor are the highest available, while the multipliers from reducing taxes on the wealthy are the lowest available. Why? 

There are a number of reasons why this is the case, but the biggest is the marginal propensity to consume for the poor, and the rich. The poor often spend 100% or MORE (using credit) of their incomes. Giving them more money means that money gets spent, and those who receive it often spend it again, rather than saving the money. In contrast, if you give the money to a rich person in a tax cut (meaning, in the process, you may give away enough money in a tax cut to ONE rich person to be able to give unemployment benefits to several, if not DOZENS of poor folks without jobs), they are far, far more likely to save the money. 

Well, doesn't saving money help produce economic activity, you ask? Well, yes. But a cast also heals SOME illnesses. What if I have the flu? The question is not whether it can help, but whether it is the right treatment for where we are NOW. 

Increased savings helps a great deal, in a number of complex effects. However, right now, our economy is not in danger because we lack savings. What's more, cheap access to capital is being taken care of ably by Bernanke and the Fed, as he keeps interest rates low. So, access to capital is not the problem. Stimulating economic activity through consumption is the problem, as are long-term structural deficits. For that you need to put money in the hands of those who will USE it.

And, while the government is deciding on who that is, we might as well ask ourselves what kind of nation it is we want to live in, and make some value judgments about how we think it best, and most moral and right to distribute the incidence of taxation. 

All that brings me back to my fundamental points to take away: 

1. The multiplier effect from jobless benefits, and other assistance to the poor such as food stamps and job training programs is as good as you get in increasing demand. 
2. Increased savings by the rich do NOT create jobs as well as creating demand for the existing businesses. 
3. If access to capital is needed, the Federal Reserve is already doing that more cheaply and effectively than the tax code can. 
4. The cost of providing benefits through a tax break to one person in the top 2% by income on average is similar to the cost of providing the same stimulus to the economy through improving the lives of several dozen poor people. It's the logical thing to do, and the ethical thing to do.