Saturday, September 10, 2011

The American Jobs Act

The big ticket items in the $447 billion stimulus recovery jobs act that President Obama announced in his address at the Capitol on Thursday include:
  1. $65 billion in cuts to employer payroll taxes
  2. $35 billion for employment of teachers, police and firefighters
  3. $30 billion for school modernization
  4. $50 billion infrastructure investment
  5. $175 billion in cuts to employee payroll taxes
  6. $49 billion for extended unemployment insurance/UI reforms
The most straightforwardly effective components of the package for increasing aggregate demand are #2, #3, #4 and #6. Direct spending on school buildings (#3) and infrastructure (#4) increase the government purchases component of demand (and "Ricardian" or "crowding out" effects that would reduce the impact in some models are irrelevant now). Cutbacks by state and local governments have become a big drag on the economy - state and local governent employment has fallen by over 650,000 over the past three years. The funding for employing teachers and "public safety and first responder personnel" (#2) will put a brake on that trend. That is, it will be an increase in demand (again through the government purchases component) and employment relative to what would occur otherwise.

Extending unemployment insurance (#6) is effective because much of the money goes to people who will spend it (i.e., people who are "credit constrained" from smoothing out their consumption over time).  This increases the consumption component by raising disposable income.  The release from the White House discusses some possible reforms to the unemployment insurance program as well - these are not detailed enough to evaluate, but possibly they might help mitigate one of the downsides of unemployment insurance, which is that it can reduce incentives to work (though I don't think that is a really significant contributor to unemployment now).

There is more uncertainty about the effectiveness of the social security payroll tax components.  Payroll taxes are the "contributions" paid equally by employers and employees (although employees only observe half of the tax through the "FICA" line on their pay stubs, in the long run, the burden of the entire tax - the "incidence" - largely falls on employees because their wages would be higher if employers did not have to make their contribution).

The largest part of the act (#5) is a one-year reduction in the employee contribution to 3.1% - the standard contribution is 6.2%, but was temporarily cut to 4.2% for this year in the deal that was struck in late 2010.  So, basically, this extends the existing cut, and adds another 1.1% to it.  As with unemployment insurance, the effect of a tax cut in increasing consumption depends on whether it is spent.  Households that are credit-constrained (living "paycheck to paycheck") are more likely to change their behavior.  In this regard, it is less well targeted than the unemployment insurance extension, but it is superior to an overall income tax cut. Because the payroll tax is somewhat regressive, only applying to the first $106,800 of wages (and not at all to capital income), the benefits go largely to the "middle class."  Although the primary desired effect is to increase consumption demand, even the parts of the tax cut that are not spent do have the benefit of helping improve the financial position of households.  Large debt burdens are part of the reason recoveries from "balance sheet recessions" are typically slow, so if part of the tax cuts goes to pay down debt, that could serve to hasten the return to normal household spending behavior.

The employer part of the payroll tax cut (#6) can be thought of as a positive "supply shock" lowering unit labor costs (in the short run, with lots of labor market slack, it won't lead them to raise wages).  In a traditional Keynesian framework, this would shift out the aggregate supply curve (or, equivalently, shift down the Phillips curve).  In a "New Keynesian" model, this is a reduction in the real marginal cost term in the New Keynesian Phillips Curve.  Since the binding constraint on the economy is on the demand side, the usefulness of this part of the policy appears questionable.  Indeed, reducing costs is deflationary, and deflation is a very bad thing.  But it is a bad thing that the Fed is determined to prevent, and that is why this part of the package may have a positive effect.  The Fed seems very averse to letting inflation become negative, but also very careful to try to keep it from going above 2% (in doing so, its placing too much weight on the "price stability" part of its mandate relative to the "maximum employment" part, as this justly-praised speech by Chicago Fed President Charles Evans argued). By putting downward pressure on costs, and therefore prices and inflation, the employer-side tax cuts may create more space for the Fed to act more aggressively.

An important part of the proposal is still to come - President Obama said that he would deliver plans to "pay for" the jobs act (i.e., offsetting tax and spending changes, presumably within the standard 10-year window customarily used to assess budget proposals).  This may be politically necessary, but, as I argued recently, there is no economic urgency for doing this, and I worry that political gridlock over paying for the bill could derail taking action now, which is urgent.

Its also worth noting that, while the exact timing of some of the provisions is unclear, it looks like most of the effect occurs in 2012.  That's a good thing, but even under the optimistic assumptions that something like this bill is enacted, and the Fed finds a will and a way to take more effective action, the economy is in a very deep hole and unemployment will still be elevated at the end of 2012. The expiration of the tax cuts puts in place an automatic fiscal contraction for 2013 (this is where the idea of "state contingent" policies would help, but would raise the headline cost, which is politically unpalatable right now).

Private-sector estimates suggest the bill would have a significant impact: Macroeconomic Advisors says it will raise GDP by 1.3% and increase employment by 1.3 million next year; Moody's (via Brad Plumer) puts it at 2% of GDP and 1.9 million jobs.  See also: Gavyn Davies, Paul Krugman, Ezra Klein, Mark Thoma.

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