Question

1.Blinder and Zandi estimated multipliers for different kinds of tax cuts. They estimate that the multiplier for the Earned Income Tax Credit, a program for low-wage workers, is 1.24, while the multiplier for an across-the-board tax cut for all tax payers is 1.02. Why do you think the across-the-board tax cut has a lower multiplier?

2.Blinder and Zandi write:

“Without the policy responses of late 2008 and early 2009, we estimate that:

• The peak-to-trough decline in real gross domestic product (GDP), which was barely over 4%, would have been close to a stunning 14%;
• The economy would have contracted for more than three years, more than twice as long as it did;
• More than 17 million jobs would have been lost, about twice the actual number.
• Unemployment would have peaked at just under 16%, rather than the actual 10%;
• The budget deficit would have grown to more than 20 percent of GDP, about double its actual peak of 10 percent, topping off at $2.8 trillion in fiscal 2011.
• Today’s economy might be far weaker than it is — with real GDP in the second quarter of 2015 about $800 billion lower than its actual level, 3.6 million fewer jobs, and unemployment at a still-dizzying 7.6%.”

Do you think Blinder and Zandi have views closer to Keynes or Say? Explain. If they are right about their conclusions, why do you think the stimulus package was politically unpopular among a large part of the population?

Answer 1

Answer 1;

There is difference in the tax multiplier for Earned Income tax Credit and across the borad tax cut. This is because Earned Income tax credit increases the after tax income by a larger percentage for those at the bottom of the income scale as compared to those on the top and middle income scale. This makes these taxes progressive and since Marginal propensity to consume of those at the bottom of the income scale is higher than those in the top, this increases the value of multiplier in case of Earned Income Tax credit.

On the other hand, the multiplier for across the board tax cut is smaller because it raises after tax income by a larger percentage for those at the top of the income scale and this makes these taxes regressive. Since MPC of those at the bottom is more than those at the top, this increases the value of tax multiplier in case of across the board tax cut.

Thus, across the board tax cut has a lower multiplier than Earned income tax credit for low wage workers.