Tax Cuts and Job Growth: They’re Just Not That Into Each Other

May 1st, 2012 at 9:49 am

Bruce Bartlett has a nice piece in the NYT this AM on the (non-)relationship between the tax wedge and employment rates across countries.   The wedge is the gap between what employers pay and what employees receive after taxes come out.   Reduce the wedge, the theory goes, and since you’re making employees cheaper to employers, they’ll hire more of them.

Most economists believe there’s something to this.  After all, demand curves slope down, and all else equal, lowering cost should increase quantity.   But the problem is demand curves move around a lot, and at a time like this, for example, the key determinant of hiring is going to be more demand.  Even at reduce rates, employers won’t “buy” more workers if they don’t need them.

That doesn’t mean measures like the payroll tax holiday are useless.  For one, by increasing the after-tax wage, they put more money in people’s pockets, and that in-and-of-itself creates more demand.  Also, when the economy turns up and demand begins to come back, a cut in the tax wedge can give cautious employers a nudge to pull some future hires forward into the present.

But as Bartlett shows, there’s no correlation between the tax wedge and employment rates across countries.  The figure shows the scatterplot.  There’s a slope there but it’s nowhere close to significant and the R-square is 0.005, meaning there’s no cross-country correlation between the magnitude of the tax wedge and the employment rate.  A better test would be changes across time, and such panel data analyses find a bit more than the cross-sectional view.  But not much.  Here again, small responders win.

The three policy ideas I hear most often for greater job creation are cut taxes, cut regulation, and more education.  While I support the latter, especially for those whose access is blocked by income constraints, none of these ideas will do much to increase the quantity of jobs.

What will?  Greater consumer demand, an end to deleveraging, a growing housing market, more domestic production of the goods we consume, new innovations that generate hungry, job-creating start-ups financed by now-idle capital, clean energy investment, and if all else fails, a national program to rebuild and repair the nation’s infrastructure, from roads to schools.

Boom…there’s your jobs program.  And I can think of policies that go along with each one of the above—in order: consumer demand: stimulus; housing: loan mods and principal reduction for some, time for others; more domestic production: weaker dollar, smaller trade deficits, manufacturing policies; innovation/start-ups: R&D, public/pvt/academic partnerships; infrastructure: FAST!

I’m being a little bit glib here…each one of those ideas deserves a lot more ink.  All’s I’m saying is that here is where the hard work is in terms of job creation—not in the passivity of failed supply-side, trickle-down, deregulatory BS (and I don’t mean Bowles-Simpson).

Bartlett gets the last word:

The reason that unemployment is high clearly has nothing to do with taxes. Consequently, there is no reason to think that reducing taxes further will do anything to raise employment by reducing the tax wedge.

 

Source: Bartlett, NYT, using OECD data.

 

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3 comments in reply to "Tax Cuts and Job Growth: They’re Just Not That Into Each Other"

  1. Aaron says:

    “What will? Greater consumer demand, an end to deleveraging, a growing housing market, more domestic production of the goods we consume, new innovations that generate hungry, job-creating start-ups financed by now-idle capital, clean energy investment, and if all else fails, a national program to rebuild and repair the nation’s infrastructure, from roads to schools.”

    Hmph. Of course greater consumer demand would create jobs. Deleveraging would probably help if you could do it without reducing consumption. Then, things begin to get shaky.
    A growing housing market? That just isn’t a realistic goal, and is more likely to occur after a recovery.
    New innovations that create start-ups? This is pretty vague, but there is actually already a ton of capital out there for start-ups in the tech and pharma sectors (and others). Both the economics and sociology/organizations literatures have grown more skeptical about the job-creating powers of start-ups. Most are restaurants and other small businesses. Startups create a large number of jobs, but they also lose them when they are fired. And start-ups can replace existing jobs through a process of “creative destruction” in which innovation occurs but no jobs are gained. Promoting startups has been popular politically because it is cheap, easy, and appealing, but results are mixed.
    Clean energy investment? It should be a priority, but it isn’t a huge job-creator.
    A national program to rebuild the country’s infrastructure? Now we’re talking. Direct hiring *should* work for job creation if it was politically feasible.


  2. davesnyd says:

    You’ve previously been lukewarm at best on non-school infrastructure projects. Has your thinking changed? If so, why?

    I think that pushing demand by infrastructure spending now makes a lot of sense. Except, what does that demand purchase? A lot of it is imported “stuff” that used to be made here. Until we correct the trade imbalance, I don’t see how structural changes will come about in the economy.

    Until the cost of overseas labor is equivalent to American– if not by internal motion, then by the application of appropriate (i.e., for labor law violations, environmental protection, consumer product safety, currency manipulations, and the like) tariffs– it’s hard to see how our economy goes back to one where everyone can work hard and reap the benefits of their efforts.


    • Jared Bernstein says:

      I’m all for investing a lot more in all forms of public infrastructure. I’ve argued that some of this work seems to have become more capital intensive, so the labor requirements may have come down somewhat. But there are still a lot of jobs there, and many other types of gains to the society and economy from doing this.


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