Common Sense and Opportunity Cost

By: Larry Walker, Jr.

According to the Speaker of the House of Representatives, Democrat, Nancy Pelosi, “For every dollar a person receives in food stamps, $1.79 is put back into the economy. It is the biggest bang for the buck when you do food stamps and unemployment insurance. The biggest bang for the buck.”

It’s the biggest bang for the buck versus what? There is a basic concept in economics known as opportunity cost, which teaches us that for every choice we make, there is a cost which is related to the next-best choice available. In other words, if unemployment and food stamps provide the biggest bang for the buck, does that mean it’s better to be unemployed than employed? Let’s put this under the microscope.

Joe the Salesman generates commission income for his company of 5% of the amount of sales produced. Out of the income generated for the company, Joe receives a cut of 50%. Let’s assume that Joe personally makes gross pre-tax commission income of $50,000 in a year. In order to generate this income Joe’s sales must have been $2,000,000 for the year. The company Joe works for receives commission income of $100,000 and pays Joe his cut of 50%, or $50,000.

What has Joe produced? Joe has contributed a total of $2,000,000 in economic activity in order to earn his pay. This $2,000,000 will multiply throughout the economy vertically and horizontally through related businesses and suppliers. Joe earns his keep and is a productive member of society.

Now let’s look at Joe after he has been laid off and becomes a recipient of unemployment benefits and food stamps:

Joe is now on unemployment and he receives $15,800 per year in unemployment benefits and $5,000 in food stamps. Joe produces nothing to receive this income. Sure, Joe still spends all of his money on rent, food and the basic necessities, but the multiplier effect can only be calculated on the $20,800 that Joe receives and spends. The unemployment checks that Joe receives are generated from unemployment insurance payments made by his former employer, leaving the employer with less money to work with, as well as a smaller amount of sales and productivity. The food stamps he receives are funded by taxpayer dollars, which are currently paid for by money, which is being borrowed by the federal government. [Note: When congress chose to extend unemployment benefits for up to 99 weeks, the added cost was also deficit-financed.]

So if we are talking about the multiplier effect, then which Joe has the greatest impact, the working Joe, or the unemployed Joe?

Assuming that Nancy Pelosi was correct in her statement that, for every dollar spent on unemployment insurance and food stamps $1.79 is added to the economy, and assuming that the same multiple applies to the private sector, which sector will provide the biggest bang for the buck?

Working Joe produced $2,000,000 in gross sales, so he will have added $3,580,000 in economic activity.

Unemployed Joe produced nothing, but did consume $20,800 worth of goods and services. However, out of this, $15,800 was taken from his former employer, and $5,000 from taxpayers, which reduced their consumption dollar-for-dollar. In effect, unemployed Joe took $20,800 from another working Joe and spent the other working Joe’s money. But the other working Joe would have spent or invested the same money anyway. Thus, in my opinion, the multiplier effect of unemployed Joe is zero, since just a different Joe is spending the same money.

To make matters worse, not only is the unemployment and food stamps multiplier zero, it is negative, in my opinion. Why? Because of the fact that unemployed Joe’s food stamps and part of his unemployment benefits were paid for with deficit-financed money. Generations of working Joe’s across the country will be paying interest on this debt, through higher taxes, for years to come and eventually will have paid more than twice the initial amount in principal and interest payments. On top of this, Joe’s former employer is on the hook for higher unemployment insurance premiums, which could have been invested or spent to create additional jobs.

Lesson: All private sector employees produce more than they are paid, that’s the whole point. Unemployed persons produce nothing and merely spend dollars that would have been spent or otherwise invested more productively. The biggest bang for the buck is achieved through implementing government policies, which promote private sector growth, not through unemployment insurance and food stamps.