How the American Rescue Plan Can Help Illinois’ Fiscal Position in the Short-Term
In economics, there is a concept called the “Marginal Propensity to Consume” or “MPC”. MPC describes the relationship between income and consumption of goods (the spending of income) — or more specifically: how someone’s consumption (spending of income) changes when that person’s income changes.
A person’s MPC is calculated by determining the change in consumption divided by the change in income. For example: if someone’s income increases by $10, and they spend $8 of that $10, that person’s MPC is equivalent to 0.8.
Research has found that people with lower levels of disposable income have much higher MPCs. This means lower-income earners spend more of every additional dollar they receive compared to people at the high end of the income distribution. That’s because people at the higher end of the income distribution are not likely to change their habits as they are already spending and saving much larger amounts of money.
Why Is MPC Important to Fiscal Policy?
MPC is important because it has been linked to what fiscal policy analysts like CTBA call an “economic multiplier.” An economic multiplier — also referred to as a spending multiplier — describes how much a change in income a person or household will generate in the economy.
Figure 1 highlights how those with higher MPC — again, income-earners at the bottom of the income distribution who are more likely to spend additional income — have higher economic multipliers, and thus every additional dollar spent will stretch a bit farther. According to Figure 1, someone with an MPC of 0.8 has a corresponding multiplier of 5, which means if someone with an MPC of 0.8 spends $80, that $80 could equal $400 circulating in the economy.
What do MPCs and multipliers have to do with the American Rescue Plan?
The American Rescue Plan Act — or “ARP Act” — is an economic stimulus package meant to increase the speed at which the country will recover from the economic and health impacts of the COVID-19 pandemic.
The concept of MPC and economic multipliers is the key to why Illinois will benefit from the ARP Act.
Under the ARP Act, individuals filing single are eligible for a stimulus of $1,400 in direct emergency payments if their Adjusted Gross Income (“AGI”) was less than $75,000 ($150,000 for joint filers). Those with dependents are also eligible for additional funds.
The direct payments mean additional income into the hands of lower- and middle-income earners who are more likely to spend the additional income than save it, therefore having higher MPCs and a stronger impact on getting the economy back on track.
Those households that received similar direct economic checks during the pandemic under the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act unequivocally backed the theory of MPC, as seen in Figure 2.
The Becker Friedman Institute at the University of Chicago found that many households planned to spend the money or pay off debts — whether it be on monthly bills, rent, or mortgage backlog — or spending on eating out, seen in Figure 3.
The spending these individuals did and will continue to do has helped the economy, as the stimulus checks intended. That’s because, for every $1 of stimulus payments delivered, it is estimated that the economy will see an additional $1.09 boost.
There is little reason to believe this is not the case for the ARP Act emergency payments. In Illinois alone, a minimum of 4,234,338 taxpayers was eligible to receive the full $1,400 direct payments, which results in approximately $6 billion in additional income into the hands of those who need it most, and a potential boost of approximately $6.5 billion flowing through Illinois’ economy, according to an analysis of Illinois Department of Revenue data conducted by CTBA.
The ARP Act also authorizes expanded tax credits, most notably the Earned Income Tax Credit (“EITC”) and the Childcare Tax Credit (“CTC”).
The ARP Act raised the maximum EITC for adults without children from $543 to $1,502. It would also lower the age eligibility for the childless EITC from 25 to 19 and eliminate the upper age limit, which currently bars the credit for childless people age 65 and older. This means more money in the hands of lower- and middle-income households that are more likely to spend the additional tax credits.
The ARP Act also increased the CTC maximum amount to $3,000 per child and $3,600 for children under age 6, and would also extend the credit to 17-year-olds. The increase in the maximum amount would begin to phase out at $150,000 in income for married couples, again putting more money in the hands of lower- and middle-income households.
For every $1 spent on the EITC, the economy could see a boost of an additional $1.27. For every $1 spent on the CTC, the economy could see a boost of an additional $1.25. That is because it is providing more assistance and aid to lower-income households who will likely spend the additional income in the economy by paying bills and debts, shopping locally, and eating out at a local establishment.
The Indirect Benefit of the ARP Act in Boosting Illinois’ Economy
Aside from the individual and family support provided in the stimulus bill, the ARP Act provides aid and assistance for government-run programs, all of which have positive impacts on the people in the programs, but also on Illinois’ economy.
The ARP Act provides $350 billion to help states, counties, cities, and tribal governments cover increased expenditures, replenish lost revenue and mitigate economic harm from the COVID-19 pandemic.
Illinois is estimated to receive $7.5 billion for state expenses, $2.7 billion for metropolitan cities with more than 50,000 people, $738 million for towns with fewer than 50,000 people, $2.5 billion for counties, and $254 million for state capital projects. This comes to $13.7 billion in total ARP Act funding for the state and local governments.
This is valuable revenue for Illinois to close budget holes for FY 2021 and FY 2022, but the aid to state and local governments is far more beneficial than just the initial revenue. The aid to state and local governments is predicted to boost the economy by $1.34 for everyone $1 in spending.
When state and local governments cut spending as a result of a decrease or lack of growth in revenue from the prior year, this often leads to cuts in programs or reductions in services provided by state and local governments. Those cuts or reductions typically result in a decrease in jobs for the workers that provided the programming and services. With the ARP Act providing an additional $7.5 billion for the state of Illinois, Illinois can prevent service cuts, rehire furloughed state and local employees, and reduce the risk of permanently cutting jobs. State and local employees then spend their salaries in their communities, which offers that extra boost to the state’s economy.
Conclusion
While Illinois has been given a lifeline with the ARP Act, it is not a long-term solution. When the economic boost is over, Illinois will be back where it was before the pandemic: fighting to raise enough revenue to keep up with the increased cost of providing services for residents.
It is important to understand why Illinois will likely make it through FY 2021 and FY 2022 without too steep of service cuts, but beyond FY 2022, Illinois’ fiscal future is uncertain. One thing is for sure, though: to prevent service cuts and job losses, Illinois needs to keep searching for long-term revenue options that are fair and stable.
