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Is Unemployment Insurance Stimulative?

by Matt Mitchell on July 19, 2010

in Economic Policy, Stimulus

Alan Blinder has an interesting article in today’s Wall Street Journal. 

In it, he says that the Obama Administration is on the right policy track in its attempt to extend unemployment benefits, create more fiscal stimulus, and permit the Bush tax cuts to expire for people earning more than $250,000. 

He makes a claim that has become increasingly popular: policies that tax the rich and redistribute to the poor are not only compassionate, they are stimulative. There was a time when those on the left talked about a tradeoff between redistribution and growth. But Blinder and others now argue that redistribution is, on net, stimulative; that it is possible to have one’s cake and eat it too. 

Blinder begins by conceding a point to the opponents of more generous unemployment insurance. He writes:  

[L]onger-lasting benefits dull the incentive to seek work, which in turn drives up unemployment. Economic research suggests they are right.

But, he says, “one shouldn’t exaggerate the magnitudes.” Furthermore, he sees reason to believe that unemployment benefits can be stimulative. The key to this reasoning is his assertion that the poor are more likely to spend a marginal dollar than the wealthy. That’s why we can tax the wealthy, redistribute to the poor, and see a net gain.

He writes:

[C]onsider three different ways to add a dollar to the budget deficit: increase unemployment benefits by $1, give a $1 tax cut to someone earning $50,000 a year, or give a $1 tax cut to someone earning $5 million a year.

While the immediate impacts on the budget are identical, the near-term spending impacts are not. The unemployed worker struggling to make ends meet will likely spend the entire dollar right away. The $50,000 earner probably will spend the lion’s share of it, saving just a bit—that’s what most Americans do. But the $5,000,000 earner probably will save most of the new-found dollar.

Blinder is referring to the “marginal propensity to consume.” Keynesians have long-argued that the poor have higher marginal propensities to consume than the wealthy. That is, Keynesians believe that if you tax a wealthy guy and redistribute the revenue to a poor guy, the economy will actually grow in the short run. Why? The wealthy guy wasn’t going to spend that money (or at least not much of it) anyway. He was just going to let it sit in his bank account (never mind that savings makes its way into aggregate demand as investment—buy Keynesians have other stories for why that doesn’t work). The poor person, however, is different. He will go out and spend that dollar right away, leading to a multiplier in terms of growth.

In my mind, this makes theoretical sense. The problem is: it doesn’t seem to be true. And President Bush’s Stimulus I provides the evidence. Economists Claudia Sahm, Matthew Shapiro and Joel Slemrod studied the way people spent the stimulus checks that were sent out in the first half 2008. Using data from the Reuters/University of Michigan Survey of Consumers, they found that spending patterns were “strongly at odds with the conventional wisdom.” It turns out that the poor were actually less likely to spend their 2008 stimulus checks than the wealthy. What’s more, analysis of the 2001 stimulus found much the same thing.

Now there may very well be humanitarian reasons for unemployment insurance (I’ll leave it to others to debate those). But is seems to me that the data are making it increasingly more difficult to argue that redistribution through unemployment benefits is both humanitarian and stimulative.

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