Lets not reduce the incentive to find work. A federal tax holiday is a better way to cut the high jobless rate.
The current debate over extending and increasing federal unemployment benefits encapsulates the disagreement between the Democrats in power in Washington and their Republican opponents. What the consequences will be of raising unemployment benefits in todays depressed economy is at issue.
The most obvious argument against extending or raising unemployment benefits is that it will make being unemployed either more attractive or less unattractive and thereby lead to higher unemployment. Empirical research supports this view.
The Democratic retort is that the economy today is so different from the past that we have to suspend our traditional understanding of economics. With five job seekers for every job opening the unemployed are desperate for work and increasing unemployment benefits will have very little if any disincentive effect. This view hinges on a total change in employee behavior from normal times to the current period of the Great Recession.
On the face of it the idea that higher unemployment benefits wont lead to more unemployment doesnt make much sense. Imagine what the unemployment rate would look like if unemployment benefits were universally $150000 per year. My guess is wed have a heck of a lot more unemployment. Common sense and personal experience indicate higher unemployment benefits will make unemployment less unattractive and thereby increase unemployment even in the Great Recession. As the chart nearby clearly shows since the 1970s theres been a close correlation between increased unemployment benefits and an increase in the unemployment rate. Those who argue that things are different today dont have the data to back up their claims.
The Democratic argument also ignores the impact of unemployment benefits on employer costs. Employers dont usually hire people to assuage their consciences. They hire people to make after-tax profits. And if workers require more pay because of higher unemployment benefits employers will hire fewer employees. Whether increased unemployment benefits incentivize workers to work less or disincentivize employers from hiring more workers the effect will be the samehigher unemployment.
The second point made by the Obama administration is that unemployment benefits are a great way to stimulate demand. Increased unemployment benefits operate quickly and the recipients spend what they get which makes these stimulus funds the best bang for the buck.
Here again the facts are in dispute. Studies have shown that previous stimulus spendingmuch of which was also targeted for the poor and unemployedwas to a large extent saved and not spent. But Im not going to rest my case on the obvious failure of Washingtons prior stimulus packages. Based upon the above logic (as described in the January 2009 white paper co-authored by White House economists Christina Romer and Jared Bernstein) the administration forecast that the unemployment rate would be a little above 7.3 in the third quarter of this year. That isnt going to happen.
The flaw in their logic is that when it comes to higher unemployment benefits or any other stimulus spending the resources given to the unemployed have to be taken from someone else. There isnt a tooth fairy or as my former colleague Milton Friedman repeated time and again there aint no such thing as a free lunch. The government doesnt create resources. It redistributes them. For everyone who is given something there is someone who has that something taken away.
While the unemployed may spend more as a result of higher unemployment benefits those people from whom the resources are taken will spend less. In an economy the income effects from a transfer payment always sum to zero. Quite simply there is no stimulus from higher unemployment benefits.
To see this imagine an economy that produces 100 apples. If 10 of those apples are given to the unemployed then people who otherwise would have had those 10 apples now wont. The stimulus of 10 apples for the unemployed is exactly offset by the destimulus of 10 apples for those people from whom the 10 apples were taken.
Given the massive inefficiencies the government creates in securing resources from the private sector there may also be a large negative income effect over wide ranges of stimulus spending. This is the proverbial toll for the troll. These massive inefficiencies could lead to lower output.
To see these effects clearly imagine a two person economy in which one of the two people is paid for being unemployed. From whom do you think the unemployment benefits are taken? The other person obviously. While the one person who is unemployed may buy more as a result of unemployment benefits the other person from whom the unemployment sums are taken will buy less. There is no stimulus for the economy.
But it doesnt stop there. While the income effects sum to zero the substitution effects aggregate. The person from whom the unemployment funds are taken will find work less rewarding and will work less. The person who is given the unemployment benefits will also find work relatively less rewarding and will therefore work less. Both people in this two-person economy will be incentivized to work less. There will be less work and more unemployment.
Not only will increased unemployment benefits not stimulate the economy they will at the same time lower the incentives for people to work by reducing the amount people are paid for working and increasing the amount people are paid for not working. Its pretty basic economics.
No one opposes unemployment benefits as a transition aid for people to get back on their feet and find a new job. Unemployment benefits are a safeguard for individuals down on their luck. But to argue that unemployment benefits actually reduce unemployment is disingenuous at best and could induce our government to enact policies that have the effect of destroying our nations production base from whence all benefits ultimately flow.
Any government program that would reduce unemployment has to make working more attractive for both employer and employee. Since late 2007 the federal government has spent somewhere around $3.6 trillion to stimulate the economy. That is a lot of money.
My suggestion would have been to take all $3.6 trillion and declare a federal tax holiday for 18 months. No income tax no corporate profits tax no capital gains tax no estate tax no payroll tax (FICA) either employee or employer no Medicare or Medicaid taxes no federal excise taxes no tariffs no federal taxes at all which would have reduced federal revenues by $2.4 trillion annually. Can you imagine where employment would be today? How does a 2.5 unemployment rate sound?
Mr. Laffer is the chairman of Laffer Associates and co-author of The End of Prosperity: How Higher Taxes Will Doom the EconomyIf We Let It Happen
Lets not reduce the incentive to find work. A federal tax holiday is a better way to cut the high jobless rate.
The current debate over extending and increasing federal unemployment benefits encapsulates the disagreement between the Democrats in power in Washington and their Republican opponents. What the consequences will be of raising unemployment benefits in todays depressed economy is at issue.
The most obvious argument against extending or raising unemployment benefits is that it will make being unemployed either more attractive or less unattractive and thereby lead to higher unemployment. Empirical research supports this view.
The Democratic retort is that the economy today is so different from the past that we have to suspend our traditional understanding of economics. With five job seekers for every job opening the unemployed are desperate for work and increasing unemployment benefits will have very little if any disincentive effect. This view hinges on a total change in employee behavior from normal times to the current period of the Great Recession.
On the face of it the idea that higher unemployment benefits wont lead to more unemployment doesnt make much sense. Imagine what the unemployment rate would look like if unemployment benefits were universally $150000 per year. My guess is wed have a heck of a lot more unemployment. Common sense and personal experience indicate higher unemployment benefits will make unemployment less unattractive and thereby increase unemployment even in the Great Recession. As the chart nearby clearly shows since the 1970s theres been a close correlation between increased unemployment benefits and an increase in the unemployment rate. Those who argue that things are different today dont have the data to back up their claims.
The Democratic argument also ignores the impact of unemployment benefits on employer costs. Employers dont usually hire people to assuage their consciences. They hire people to make after-tax profits. And if workers require more pay because of higher unemployment benefits employers will hire fewer employees. Whether increased unemployment benefits incentivize workers to work less or disincentivize employers from hiring more workers the effect will be the samehigher unemployment.
The second point made by the Obama administration is that unemployment benefits are a great way to stimulate demand. Increased unemployment benefits operate quickly and the recipients spend what they get which makes these stimulus funds the best bang for the buck.
Here again the facts are in dispute. Studies have shown that previous stimulus spendingmuch of which was also targeted for the poor and unemployedwas to a large extent saved and not spent. But Im not going to rest my case on the obvious failure of Washingtons prior stimulus packages. Based upon the above logic (as described in the January 2009 white paper co-authored by White House economists Christina Romer and Jared Bernstein) the administration forecast that the unemployment rate would be a little above 7.3 in the third quarter of this year. That isnt going to happen.
The flaw in their logic is that when it comes to higher unemployment benefits or any other stimulus spending the resources given to the unemployed have to be taken from someone else. There isnt a tooth fairy or as my former colleague Milton Friedman repeated time and again there aint no such thing as a free lunch. The government doesnt create resources. It redistributes them. For everyone who is given something there is someone who has that something taken away.
While the unemployed may spend more as a result of higher unemployment benefits those people from whom the resources are taken will spend less. In an economy the income effects from a transfer payment always sum to zero. Quite simply there is no stimulus from higher unemployment benefits.
To see this imagine an economy that produces 100 apples. If 10 of those apples are given to the unemployed then people who otherwise would have had those 10 apples now wont. The stimulus of 10 apples for the unemployed is exactly offset by the destimulus of 10 apples for those people from whom the 10 apples were taken.
Given the massive inefficiencies the government creates in securing resources from the private sector there may also be a large negative income effect over wide ranges of stimulus spending. This is the proverbial toll for the troll. These massive inefficiencies could lead to lower output.
To see these effects clearly imagine a two person economy in which one of the two people is paid for being unemployed. From whom do you think the unemployment benefits are taken? The other person obviously. While the one person who is unemployed may buy more as a result of unemployment benefits the other person from whom the unemployment sums are taken will buy less. There is no stimulus for the economy.
But it doesnt stop there. While the income effects sum to zero the substitution effects aggregate. The person from whom the unemployment funds are taken will find work less rewarding and will work less. The person who is given the unemployment benefits will also find work relatively less rewarding and will therefore work less. Both people in this two-person economy will be incentivized to work less. There will be less work and more unemployment.
Not only will increased unemployment benefits not stimulate the economy they will at the same time lower the incentives for people to work by reducing the amount people are paid for working and increasing the amount people are paid for not working. Its pretty basic economics.
No one opposes unemployment benefits as a transition aid for people to get back on their feet and find a new job. Unemployment benefits are a safeguard for individuals down on their luck. But to argue that unemployment benefits actually reduce unemployment is disingenuous at best and could induce our government to enact policies that have the effect of destroying our nations production base from whence all benefits ultimately flow.
Any government program that would reduce unemployment has to make working more attractive for both employer and employee. Since late 2007 the federal government has spent somewhere around $3.6 trillion to stimulate the economy. That is a lot of money.
My suggestion would have been to take all $3.6 trillion and declare a federal tax holiday for 18 months. No income tax no corporate profits tax no capital gains tax no estate tax no payroll tax (FICA) either employee or employer no Medicare or Medicaid taxes no federal excise taxes no tariffs no federal taxes at all which would have reduced federal revenues by $2.4 trillion annually. Can you imagine where employment would be today? How does a 2.5 unemployment rate sound?
Mr. Laffer is the chairman of Laffer Associates and co-author of The End of Prosperity: How Higher Taxes Will Doom the EconomyIf We Let It Happen
