Taken as a whole, the tax hikes and spending cuts on the horizon would send us into a recession. But not all of the parts of the pending austerity crisis are created equal in terms of economic impact. So if the goal is to soften that blow to the economy, it's worth looking at which parts would be the most effective stimulus.
For example, the Bush tax cuts for upper-income earners have a relatively weak multiplier effect, as a recent report from the Congressional Budget Office reveals: They wouldn't depress GDP by very much if they expire, and they wouldn't spur GDP growth by very much if they're extended (0.1 percentage point). It's what economists call the multiplier effect: For every dollar of revenue that's lost through Bush tax cuts for the wealthy, it would produce only about $0.25, according to Moody's Analytics chief economist Mark Zandi.
By comparison, the Bush tax cuts for lower-income Americans have a much larger multiplier effect on the economy of 0.84, according to Zandi's model, as they're more likely to spend their tax savings immediately rather than tuck them away into savings accounts.
However, in terms of the biggest bang for the buck, the most effective stimulus wouldn't come from any of the Bush tax cuts: Extending federal unemployment benefits, the payroll tax holiday and the 2009 stimulus' tax cuts for low-income Americans would all be better at boosting the economy and avoiding an austerity crisis come January 2013.
Up to 2 million people could lose unemployment insurance in 2013 unless lawmakers reauthorize federal emergency benefits, as my colleague Michael Fletcher reported today. Extending them would be a cost-effective way to offset the economic drop-off at the end of the year: Zandi calculates that emergency unemployment benefits have a multiplier of 1.52 — one of the most effective forms of any stimulus that we've passed since the recession, following food stamps and subsidized work-sharing. He estimates that it would cost $40 billion to extend them for another year, producing a economic impact of about $58 billion.
Similarly, Zandi believes that the payroll tax increase would have a fiscal multiplier of 1.25. And two 2009 tax credits targeting low-income Americans — the expanded Child Tax Credit and the Earned Income Tax Credit — would have multiplier effects of 1.38 and 1.23, respectively.
That's why the CBO believes that these policies — unemployment benefits, payroll tax extension, and the CTC/EITC credits — "would have the largest effects on employment per dollar of budgetary cost in 2012 and 2013," as they reduce the marginal cost of hiring new employees and "target people most likely to spend the additional income," according to a CBO report from earlier this year. In fact, Brad DeLong and Larry Summers concluded in a recent paper that spending money on stimulus in a depressed economy could actually reduce the deficit in the long run — achieving austerity down the road without the immediate shock in the short term.
But for all their warnings about the economic apocalypse that we're facing in 2013, you aren't hearing much about the programs that would deliver the most effective bang for the buck in terms of boosting the short-term economy. Rep. Sander Levin (D-Mich.) is making a push for unemployment benefits, and Rep. Chris Van Hollen (D-Md.) has called for another payroll tax break or equivalent boost. But these have largely been sidelined by a fight over tax cuts for the wealthy that won't effect the economy — or avert the austerity cliff — very much, whichever way they go.