Friday, January 16, 2009

Marginal Propensity to Consume and Invest

The marginal propensity to consume (MPC) of poor people is high. Similarly, the marginal propensity to invest of a small scale enterprise with good prospects of future return is relatively high. Fiscal stimulus geared towards propping up these two measures would be more effective than tax cuts to the rich, argues Stiglitz. Moreover, investment in infrastructure, education and technology also helps stimulate the economy. In short, follow Keynesianism!

Tax breaks for business may prove to be a sink-hole as bad as the troubled assets relief programme.

Some of the spending in the stimulus serves multiple ends. Increased unemployment benefits have the largest multiplier effects – cash-strapped families spend every cent given – and meet vital social needs. It is imperative to provide health insurance to the unemployed: without that, a single serious incident can push a family into bankruptcy. Helping the unemployed meet house payments reduces foreclosures, addressing one of the underlying causes of the crisis. There are thus triple benefits.

We are in uncharted territory in this crisis. But household tax cuts, except for possibly the poorest, should have no place in the stimulus. Nor should business tax breaks, except when closely linked with additional investment. The one tax cut that should be included is a temporary incremental investment tax credit; it provides a big bang for the buck, encouraging companies to invest now when the economy needs the spending. Increased investments in infrastructure, education and technology, relief to states, and help to the unemployed need pride of place.