Transfer Payment
What is Transfer Payment?
A transfer payment is money the government gives to individuals without receiving a good or service in return.
Examples include Social Security, unemployment benefits, and welfare. Transfers are excluded from GDP because nothing is produced, but they redistribute income and act as automatic stabilizers.
Transfer Payment: a worked example
A government's budget outlay is $850 billion, split into $600 billion of purchases of goods and services and $250 billion of transfer payments. Only the $600 billion enters GDP as G, because the transfers buy no output. That does not make transfers invisible in the accounts. A household receiving $900 of benefits with a marginal propensity to consume of 0.9 spends $810 of it, and that $810 shows up in C. Carry it through with multipliers. Government purchases work through 1 ÷ (1 - 0.9) = 10, so $250 billion of purchases would raise real output by $2.5 trillion. Transfers work through 0.9 ÷ (1 - 0.9) = 9, because the first round of spending is the household's rather than the government's, so the same $250 billion raises output by $2.25 trillion. Same dollars, one round of spending less.
The mistake students make with transfer payment
Sorting government outlays by who receives the money gives the wrong answer. The test is whether output changes hands, not whether a household or a firm ends up holding the cash. A subsidy paid to a farm is a transfer even though a business receives it, and interest paid on government debt is a transfer as well. A teacher's salary and a payment to a contractor building a road are purchases, because labor services and a road are delivered in exchange. Sort by what the government gets back, then put only the purchases into G.
Transfer Payment questions
Why are transfer payments not included in GDP?
GDP measures the value of newly produced goods and services, and a transfer payment produces nothing on its own. The government hands over money and receives no output in return, so counting the payment and then counting what the recipient buys would record a single flow of spending twice. The recipient's purchases do enter GDP, inside consumption, which is where actual production is being demanded.
What are examples of transfer payments?
Retirement and disability benefits, unemployment compensation, welfare and food assistance, and veterans' payments are the standard household examples, and subsidies paid to farms or firms belong in the same category. Grants sent from a national government down to a regional or local one count as well, since no output moves back in the other direction. The common thread is money leaving the treasury with nothing produced in exchange, which is exactly what separates a transfer from a purchase.
Do transfer payments have a smaller multiplier than government spending?
Transfer payments carry a smaller multiplier because the first round of spending belongs to the household rather than the government. A dollar of government purchases enters aggregate demand in full and then multiplies. A dollar of transfers only enters once the recipient spends part of it, and the saved part leaks out immediately. With a marginal propensity to consume of 0.8, purchases multiply by 1 divided by 0.2, giving 5, while transfers multiply by 0.8 divided by 0.2, giving 4.
Related terms
Common comparisons
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