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Research Desk investigates: Do the rich spend less of new income than the poor?

By Dylan Matthews

PtitSeb did not ask this exactly, but this quotation he posted from Mark Zandi raises an interesting question:

Mark Zandi's op-ed in the NYT last week ... mentioned that "successful small-business owners, who power the nation’s job-creation machinery, make up one-third of these high-income taxpayers."

This reminded me of an argument that people like myself often make to defend giving money to lower-income people as a form of stimulus, which is that lower- and middle-class people tend to have a higher marginal propensity to consume than upper-income people. That is to say, if given more money from the government, the assumption is that lower- and middle-class people will be more likely to spend it, stimulating the economy now, while high-income people are likelier to save it. Now, Zandi is specifically talking about taking away from spending by small-business owners, not high-income people generally, but I thought I'd look into whether this is right, and high-income people do, in fact, save more than they spend when receiving added income.

The evidence is mixed, but seems to suggest that I was wrong. In "Do the Rich Save More?", economists Karen Dynan, Jonathan Skinner and Stephen Zeldes found a strong relationship between personal savings and income. However, other research suggests the opposite conclusion. Julia Lynn Coronado, Joseph Lupton and Louise Sheiner of the Federal Reserve studied (PDF) the effects of the 2003 tax cuts' child credit and found that the rich were actually more likely to spend most of the credit. Most of this is due to the fact that high earners were less likely to have to pay off debt:

Matthew Shapiro and Joel Slemrod did a similar study on personal income tax rebates from the 2001 tax cuts, and also found that the rich spent more:

Now, this is not ironclad evidence that letting the Bush tax cuts expire will hurt spending among high earners as much, percentage wise, as it will among lower- and middle-class people. These papers study the introduction of the cuts, and it's by no means obvious that their revocation will have an equal and opposite effect. What's more, it does not debunk the idea that services to the working class can be stimulative. See Zandi's multiplier figures for food stamps and unemployment insurance for more on that. But it does suggest that letting only high income tax cuts expire will still have a significant negative impact on spending by the rich, and thus that arguments for letting the cuts expire that are based on marginal propensity to consume hold less weight than those based on debt concerns and fairness.

By Dylan Matthews  |  August 27, 2010; 3:06 PM ET
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First post in the last Research Desk! Good work, as always. Happy trails.

Posted by: MosBen | August 27, 2010 3:41 PM | Report abuse

This does not make any sense. We're not talking about the marginal propensity to spend for middle class people. Both of your charts cut off at fairly middle class income levels (albeit a little on the side of high-middle class) - at >$100K and >75K, respectively. The tax cuts we're trying to let expire are for individuals making over $200K or families making over $250K. Marginal propensity to spend at those levels are really low because they have everything they need - and - want.

Zandy's own study showed the Bush tax cuts as an extremely ineffective stimulus, generating 32 cents for every dollar in those tax cuts, while dollars geared for the poor and middle class were far more effective - food stamps generating $1.74, work-share at $1.69 and unemployment benefits at $1.57. A payroll tax holiday was pegged at $1.24 of economic activity for every dollar in those tax cuts.

Posted by: thepeoplesview | August 27, 2010 4:26 PM | Report abuse

Very interesting post.

I think it's important remember exactly what is meant by save and spent.

Very few people save money these days by burying dollar bills under the mattress. Most often (and particularly for the rich), saving is done by purchasing bonds or stocks.

An increase in savings by purchasing stocks or bonds by a single individual doesn't necessarily reduce aggregate demand.

Suppose a person takes $10,000 from a tax cut and invests it into a stock. The supply of that stock doesn't change, and so our investor transfers $10,000 to another person in exchange for ownership rights to a company.

This second investor now has $10,000, which they will either a) save or b) spend. Even if the answer is a), there is a fixed stock of investment options at the moment. At some point, that money will be spent by one of those individuals selling stock, or a corporation will try to raise new funds via a stock or bond issue at which point the funds are going towards the corporation, presumably for use.

What if the funds are used to pay off debt? I argue that the debt payoff was the best use of funds given the choice made by the individual, and allows that individual greater leeway for future spending. More importantly, that debt payment has become someone else's income.

Of course, I have neglected bank accounts to this point. If the money ends up as a demand deposit, it will not lead to new spending. Banks are not going to change their lending due to new reserves because they are capital restrained, and so the reserves just pile up at banks as we have seen in recent years.

However, this raises the question of who is more likely to deposit a marginal dollar into a demand deposit account? A rich person (who probably doesn't keep money in a bank except for liquidity purposes, and are limited ultimately by the FDIC insurance limit) or an average joe?

Posted by: justin84 | August 27, 2010 4:28 PM | Report abuse

"Marginal propensity to spend at those levels are really low because they have everything they need - and - want."

Have you actually met anyone making $250,000+? I can assure you that while they have everything they need, they do not have everything they want - especially at $250,000/yr or close to it. Their spending habits are often quite ridiculous from a middle class perspective.

Posted by: justin84 | August 27, 2010 4:37 PM | Report abuse

$250K is hardly rich. I agree with justin84 that people in that bracket may have all they "need," but not all they want. Simple things like a new car, a trip to Europe or a deposit in a child/grandchild's 529 can occur or not occur based on what happens to the tax cuts. Whatever the politicians are going to do, let them do it soon as uncertainty may have the same effect as repeal.

Posted by: Underwriterguy | August 27, 2010 5:34 PM | Report abuse

Justin, I take your point, but I think the behavior you describe isn't going to be all that stimulative.

Paying off debt is generally going to go to a bank -- that is, to corporate income -- where it will probably sit in reserve as you describe.

Buying stock, similarly, may transfer the money to someone else, but unless that person pulls the money out of the market and spends it, it's still not generating the desired effect.

The goal is to drive consumer spending, particularly spending that winds up employing an American worker. I think on this second point the chart probably *understates* the stimulative spending of the wealthy -- they would seem more likely to spend the money on services (locally produced almost by definition) and high-end goods (where domestic manufacturing is still well represented) while the poor are more likely to buy cheaper imported options that send the money elsewhere.

Posted by: bjrubble | August 27, 2010 5:34 PM | Report abuse

I agree that you really need a chart that has a category for >200,000. Plus, you have to keep in mind that people who make more than $200,000 are only about 2% of the population if you're talking about effects on the whole economy.

Posted by: julie18 | August 27, 2010 5:57 PM | Report abuse

I find this post mystifying. Is there no research that breaks down the >$100,000 category? I can't get the stupid pdfs to open, but honestly, I find the graphs to be lacking. "High-income" doesn't equal "$75,000" or "$100,000" in my mind. Even on the individual level.

In other words, I'm with thepeoplesview on this. I expect better from this blog, quite frankly. Be specific and compare like with like next time, please.

Posted by: slag | August 27, 2010 5:58 PM | Report abuse

I also should have added that this isn't "new income"--they've been getting it for years. If they blew it all, instead of saving and investing it for the future, that's not the rest of the country's problem.

Posted by: julie18 | August 27, 2010 6:06 PM | Report abuse

--"Very few people save money these days by burying dollar bills under the mattress."--

justin84 is correct, and, I believe, has made the same point here before, as have I. Both Matthews and Klein repeatedly use the words "saved" or "savings" to characterize sums of money as not part of the economy, a vast surfeit of untold wealth, languishing for want of good use. What they really mean is that, in some respects, "savings" are out of reach of the government, useless to it in its relentless attempts at political accounting, as well as useless to it as sums that it can easily steal and utilize in its corrupt endeavors, but even there they are largely wrong. What they are mostly complaining about is that savings lie beyond the tax man's reach (and even there they are wrong, because, just as savings are invested somewhere, they generate activity that the government can show up with its gun for.)

Unless money is in a mattress, et al., it is being utilized somewhere. The money in *your* ordinary savings account might well be financing your neighbor's mortgage.

And yet, morons like Klein and Matthews will run the propaganda of trying to split the difference between spending and saving time and again, despite having it pointed out to them, time and again, that saving, in most cases, is a form of investment that *is* spending.

And that's just the most glaring idiocy in Harvard boy Matthews's post. Almost the entire thing is further nonsense, and a revealing index into the modern elite education.

Posted by: msoja | August 27, 2010 10:42 PM | Report abuse

@Ronald, you insurance is very costly you can save money on your auto insurance by making few simple changes find how much you can save

Posted by: markusjone28 | August 28, 2010 1:57 AM | Report abuse

Looking at incomes above $75K or $100K is too low. You have to start at $200K and up just to be in the top 5% and $1.4M just to be in the top 1% according to

Posted by: fakedude1 | August 28, 2010 9:03 AM | Report abuse

Of course, this ignores the fact that the poor SHOULD be trying to save more of the money.

Posted by: staticvars | August 28, 2010 10:23 AM | Report abuse

I don't understand what the graphs have to do with Obama's plan to end tax cuts for those making more than $250000. Those making in the $100,000 range are far from rich. They may be better off than someone making $30,000, but tell that to a person trying to send two kids through college and are told they make too much for grants. Instead their children are forced to take out loans that will be an albatross around their necks in a job market that may or may not find them with a job.

Posted by: marlenerose1 | August 28, 2010 2:00 PM | Report abuse

An issue not addressed in this argument is how much of the very rich's wealth is spent in the domestic economy. I would venture, much less than other citizens'.

An acquaintance is married to a very wealthy man (with assets in the hundreds of millions of dollars). They spend perhaps 30-40 percent of their time overseas, mostly vacationing, sometimes sailing their yachts, occasionally on business. This money does not flow back into the domestic economy. It helps foreign economies to balance their books. It also effects our balance of trade in a non-trivial fashion.

The same is true of where this individual invests his wealth. It doesn't go into the local bank. It goes to hedge funds and investment banks that invest heavily in the emerging economies, not in GM or local startups. This benefits the BRIC and other foreign economies, but not Americans, not even the Wall Street gangs.

This man's wealth is exceptional but even so, he's on the lower rungs of the very wealthy who are becoming or already are billionaires. A friend is preparing to put his startup on the market. For this purpose, he's made a list of over _200_ billionaires, most in the U.S., whom he will approach (indirectly, of course, these people are well insulated from we hoi poloi). Even if all of those individuals are only one-billionaires, that totals $200 billion in mostly fluid assets. That's a lot more than the combined incomes -- let alone wealth -- of workers in most of America's large cities.

Playing with numbers is the economists' favorite shell game. They tell us little and may even mislead us. That's the case with superficial exposes like that pretend to offer significant insights, but actually obscure the important realities. Coronado, Lupton, and Sheiner's study does the latter. It's a waste of time from a serious fiscal policy perspective. -- Bob Jacobson, Tucson, AZ

Posted by: bluefire1 | August 28, 2010 6:17 PM | Report abuse

"Paying off debt is generally going to go to a bank -- that is, to corporate income -- where it will probably sit in reserve as you describe."


There is a difference between new deposits and the repayment of a loan is that loans are funded in part by the bank's own capital. To the extent a bank is capital constrained and is attempting to raise capital before increasing lending activity, the repayment of debt might be considered a positive (although income from the loan flows to retained earnings, so it is possible that the bank might have preferred the loan to remain outstanding from a capital perspective, but in a given instant it is a plus to the bank's capital ratios).

In normal times, as msoja has noted, new bank deposits provide funding for new loans. Now, as we can see by the recent surge in bank reserves, that not all funds at a bank will necessarily be lent out.

If demand for credit is subdued, if banks have insufficient capital, or if banks perceive the economic environment as weak then new deposits might end up as reserves/deposits at the Fed.

Of course, if someone wishes to put their own money in a bank, it is not our place to complain that they aren't using it for the public good. In any case, the super wealthy in all likelihood aren't stashing millions into interest free demand deposit accounts - the risk adverse amongst the wealthy are far more likely to park their cash in money market funds than demand deposit accounts, effectively financing (a small share) of the national debt.

"Buying stock, similarly, may transfer the money to someone else, but unless that person pulls the money out of the market and spends it, it's still not generating the desired effect."

But by definition that person to whom the money has been transferred has pulled their money out already. Every purchase requires a sale, either by existing investors or by the issuing entity (corporation, government, etc).

If you invest in the secondary market there are two effects: you transfers your dollars to the prior holder of the shares or bonds in question, and you bid up the price of the asset, and makes all existing investors feel wealthier - perhaps their greater wealth might even encourage them to spend a bit more.

Posted by: justin84 | August 28, 2010 7:51 PM | Report abuse

Justins's discussion about what 'saving' means reminds me that it is time to remind all readers here the financial crisis isn't about a credit crisis and bank failures; it is about a housing bubble and a huge loss of 'housing wealth'.

People had LOTS of 'Savings' disappear in when the housing bubble burst. The debt taken on to buy the asset still is on household books. The difference between the rich and the not so rich is the propensity to want to hold financial assets rather than to consume. Financial assets do not directly increase production, whereas buying physical things causes new, physical things to be built.

Building up middle class balance sheets is the only way to (eventually) get out of the great recession.
Dean Baker wrote back in Nov. 2008 (so the total lost wealth is worse following another 2 years of housing declines):

"Homeowners have lost more than $5 trillion in housing wealth. There is a very well established wealth effect whereby $1 of housing wealth is estimated as leading to 5 to 6 cents of annual consumption. This implies that the loss of wealth to date would cause consumption to fall by $250 billion to $300 billion annually (1.7 percent to 2.0 percent of GDP). If you add in the loss of around $6 trillion in stock wealth, with an estimated wealth effect of 3-4 cents on the dollar, then you get an additional decline of $180 billion to $240 billion in annual consumption (1.2 percent to 1.6 percent of GDP). "

Posted by: grooft | August 30, 2010 8:05 AM | Report abuse

In a time of usurious credit cards, characterizing paying off debt as not-spending isn't terribly accurate. $100 in paying off debt frees $10-30 (or far more for people with marginal bank balances and "overdraft protection".) in annual cash flow. And, of course, if people return to their previous level of debt, that's also spending.

Posted by: paul314 | August 30, 2010 10:33 AM | Report abuse

Paying off debt is savings.

Savings equals current income less current consumption. When you pay off debt you use income that could otherwise have gone to consumption. Taking on debt to finance current consumption increases consumption relative to income --reducing savings, in other words.

If you look at it as a flow of funds process paying off debt is returning the funds you borrowed from another saver to that saver. To see the net result you have to see what they do with the funds you returned to them.

The decline in the savings rate since 1980 is largely due to consumer taking on debt to finance more consumption. Using debt to finance consumption just shifts the savings from one time period to another.

Posted by: seerrees | August 30, 2010 10:46 AM | Report abuse

"Justins's discussion about what 'saving' means reminds me that it is time to remind all readers here the financial crisis isn't about a credit crisis and bank failures; it is about a housing bubble and a huge loss of 'housing wealth'."

This is an important point. The true state of housing wealth was revealed after the artficial bubble valuations melted away.

Households thought their homes were doing all their savings for them. They were fooled by an asset bubble. Now that the bubble is gone, they have to make up for years of insufficient real savings. Society cannot save by rising home prices. If 5,000 homes are worth $1 billion in one year and $2 billion five years later, the level of real wealth did not triple - it remained constant at 5,000 homes.

Households did the right thing - they reduced consumption and started to increase their savings. This is painful, because a sudden change in spending patterns requires a period of adjustment we call a recession. Trying to get them to keep spending as if the old levels of wealth were real is counterproductive.

The best way to avoid painful economic recalculations is to not blow the asset bubbles in the first place.

Posted by: justin84 | August 30, 2010 11:12 AM | Report abuse

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