The multiplier effect
Because the concept is hooey. If the government gives a poor person $10, the government has to get it from one of
- Printing money, which causes inflation.
- Borrowing money, which takes money out of circulation somewhere else.
- Taxes, which take money out of circulation somewhere else.
So yes, there is a way that it can be claimed that the $10 turns into $26.40 of economic activity. But what that claim misses is that the $10 of taxes or borrowing also would have caused $26.40 of economic activity if it had been left where it was. I.e. we're adding $10 plus $16.40 of economic activity over here at the cost of subtracting it over there.
Printing money doesn't take money from one location, but it dilutes the value of the existing money. It effectively takes value from all the money. In small amounts, that's only moderately harmful, but in large enough amounts, it can lead to hyperinflation, which does more damage than the original dilution.
There was an economist named John Maynard Keynes who has often been misquoted. He said that during recessions national governments should run fiscal deficits so as to avoid an investment deficit. He was concerned that during recessions, people would put their money in safe investments (e.g. national bonds) rather than investing in things like new machines or buildings. So he wanted governments to engage in countercyclical investment during recessions.
He believed in things like new roads and bridges. Big capital projects that would give benefits long after being completed. Things that people would use to generate economic activity later. He was worried that during recessions, people would stop investing and simply save for the purpose of saving. Meanwhile, during booms, people would be investing because everyone was.
Keynes idea was that governments should run deficits during recessions and then run surpluses during the boom periods that followed. Under his system, the net effect would a balanced budget. It's just that the investment spending would be concentrated in the recession years while the taxes to pay for it would be concentrated in the boom years. Keynes believe in cutting taxes and increasing spending during a recession and then increasing taxes and cutting spending during the rest of the cycle.
Consumption vs. saving
Another problem is with the formulation that giving money to poor people is better than giving it to rich or middle class money. This is only true if the goal is to increase consumption. But there are few circumstances where increasing short term consumption is a valid economic goal. More generally, we try to increase savings because that increases the funds available for investment. Investment is the good thing to do with money.
Investment creates capital, which magnifies the effects of labor. So the more capital, the more effective labor is. It makes sense to pay more for labor when it creates more value. So increased wages come from increased capital, which may be physical capital like a building or a welder or it may be human capital, like an engineering class (or even just work experience).
Neither food stamps nor unemployment increase capital. You start with a living person with food stamps or unemployment benefits (or both) and finish with a living person without those. People eat the food or spend the unemployment check on rent. In the past, that gave them stuff, but it's gone now. They've consumed it. Their $10 is gone, leaving only the $16.40.
Now let's consider what happens during a normal economy when someone saves $10. The $10 goes to a bank, which then bundles it with money from a lot of other people and loans the money out to someone, perhaps to buy a new house. There, the $10 contributes to the construction of the house. It gets paid to the company that builds the house. They use that money to pay their bills, creating the same $16.40 multiplier as they money gets spent again and again.
Now we have a $10 deposit in a bank and $10 of mortgage debt. The borrower goes to work, earns $10.02 and pays $10.02. The $10 deposit is now a $10.01 deposit after the bank takes their $.01. So let's see how much economic activity we have:
- $.01 to the bank.
- $.01 in interest to the original depositor.
- $10 in house constructed.
- $10 in income to the builder.
- $16.40 in multiplier effect.
- $10.02 in income to the borrower to pay off the loan.
That's a whopping $46.44 in economic activity, and the original depositor still has the $10 which can be used again.
Even if we use a more realistic $9 loan with a $1 reserve fraction, that's still $41.80 in economic activity created without consuming the original $10. That dwarfs the $26.40 from the consumer.
It's worth noting that the reason why they said the minimum wage has a lower multiplier effect is that that study is including the lost wages as well. So if there are ten people working forty hours a week at $7.25 an hour, that's $2900 a week for a multiplier of $4756. Now, we raise the minimum wage 20%. If the employer has the same money as before, they now pay $2900 for 320 hours a week, either only employing eight people or cutting back to thirty-two hours per person.
The more general belief is that this only happens partially. So rather than cutting back to 320 hours, they might cut back to 360 hours. The equivalent of paying nine full-time workers. If the ten workers instead go to part-time, they lose about half their raise. Thus only half the multiplier effect.
What's missing though is that also happens with welfare payments. The welfare payments can substitute for wages. When they do that, they reduce the multiplier effect.
The welfare trap
Welfare can be a trap. Say you have $200 in weekly welfare benefits. If you get a job making $225 a week, you pay $25 in taxes and have essentially the same income as the $200 welfare. So your fiscal incentive to get a job is zero. If you had a $250 a week job, you might pay $30 in taxes and net $20. Is it worth working twenty hours to make $20? Or would you rather just chill? Can you afford the commuting costs on $20? Or are you still losing money at the nominally higher wage?
Of course, after six months at $250, they might give you $500 for forty hours a week. Maybe $500 a week is enough to make your new expenses and still feel like you're making something.
Even if we agree that $200 in welfare has a $328 multiplier effect, we still have to account for the lost economic activity from the $250 wage that person can't afford to earn. And don't forget the $410 multiplier effect from that.