How to Avoid the Coming Recession

I was gratified to read in this morning’s Wall Street Journal that Martin Feldstein, of all people, has joined me in calling for a fiscal stimulus to avoid a coming recession. This won’t help with the larger, long-term problem (see my post from yesterday), but it’s an important short-term step.

But how to have a fiscal stimulus without adding to the already-way-too-large national debt (now almost 70 percent larger than when Bush came to office)? Feldstein doesn’t say, but here’s the answer. All we need do is recognize one simple fact: Lower-income people spend a larger portion of whatever extra income they get than those with higher incomes (in economic jargon, lower-income people have a higher marginal propensity to consume). So every dollar of a tax cut aimed at lower-income Americans packs a bigger stimulative punch than a dollar of tax cut aimed at those with higher incomes. By the same logic, every dollar of a tax increase on higher-income people has a smaller detrimental effect on their purchases than would a dollar tax hike on lower-income people. Get it? The best way to stimulate the economy without adding to the national debt is to cut the taxes of lower-income Americans and pay for that tax cut by raising taxes on those with higher incomes. Presto – a simple formula for being both fiscally responsible and also fiscally stimulative. (That this is also a step toward a more equitable tax burden is an extra bonus.) It’s so obvious and logical I’m surprised Marty didn’t suggest it.