While economics is politics, it shouldn’t be, nor has it ever been in my mind, partisan. Sometimes the Democrats have a clear vision of the economy as with Presidents Kennedy and Clinton, while at other times the Republicans have had the clear vision as with President Reagan. Unfortunately, more often than not, neither party has a clear vision of the way the world works. Ignorance too is bipartisan!
I say that because I believe that the economic policies of the last five years have not alleviated but in fact have created the poor economy. The stimulus spending of Presidents Bush and Obama obviously didn’t reduce unemployment or bring back prosperity, and it’s easy to see why. Imagine a two person economy consisting of two farmers. If one of the farmers gets unemployment benefits, guess who pays for them: the other farmer. There is no free lunch. Stimulus policies stimulate people who receive the money and they de-stimulate the people from whom the money is taken. But in the process, stimulus policies also reduce the motivation to produce of both stimulus fund recipients and payers.
For example, the argument presented by former House Speaker Pelosi that unemployment benefits stimulate the economy is just silly. There should be some level of support for those who have lost jobs as they transition to new ones, but to argue that unemployment benefits are stimulative
is, at best, bad economic reasoning. These politicians seem to operate under the Broken Window Fallacy: concentrating on the "seen" benefits of unemployment compensation, while ignoring the "unseen" costs of the resources taken from the private economy. If you pay people more for being unemployed, don’t expect less people to be unemployed. The benefits the unemployed receive will be spent, but the people from whom those resources are taken will spend less, thus offsetting the spending increase 100%.
Applying that same logic to employment as a whole, a firm looks at the total cost to the firm for employing a person. The all-in cost includes all taxes paid. All-in costs also include incremental regulatory costs of hiring a new person, such as additional risks for a class action lawsuit or workers compensation, as well as other incremental costs such as the need to add a new bathroom or to increase the size of the parking lot. Firms incorporate all of those expenses, both current and future, when they make the decision whether to hire a worker. If gross wages paid are higher than the marginal productivity of the worker (the added value that worker will provide the company), the firm will not hire the worker. If, on the other hand, the marginal productivity of the worker is greater than the gross wages paid plus a little room for profits and costs of running a business, the worker will be hired. Companies make the decision to employ a worker based on that worker’s productivity and the total cost to the firm for hiring that worker.
Meanwhile, the worker could care less how much it costs
the firm to employ him or her. What the worker cares about is how much he or she gets net — net of all taxes, including income taxes, payroll taxes, sales taxes, property taxes, tariffs, including all impediments to the purchases of those goods and services and the receipt of those wages. The worker looks at net wages received for working and compares that amount with how much that worker would receive were he or she not to work — e.g. unemployment benefits, welfare benefits, the value of leisure, the value of being home with family, and the value of working in the underground economy. In short, the worker looks at net wages received and compares those wages to the alternative he or she would get for not working. If net wages received exceed the benefits for not working, the worker will choose to work. If the benefits for not working exceed net wages received, the worker will choose not to work.
So, putting all components of the labor market together, we have a demand for labor that depends upon gross wages paid and a supply of labor that depends upon net wages received. For employers the higher gross wages paid are, the less workers they will hire. For workers the exact reverse is true, only
for net wages received: the higher net wages received are, the more willing workers are to work.
And, of course, the difference between gross wages paid and net wages received is the government tax and expenditure wedge. The larger the gap between gross wages paid and net wages received, the more unemployment you will have. To get more people to work, work has to be more attractive for firms to hire workers and work also has to be more attractive for workers to work. Increased employment requires a reduction in the government tax and expenditure wedge.
Unemployment benefits are one obvious example of the government tax wedge, particularly when extended all the way to 99 weeks. Another example of the magnitude of the tax wedge is contained in the healthcare bill passed into law in the last Congress. For every dollar’s worth of healthcare benefits a consumer receives, the consumer only pays roughly 5 cents on the margin. There is almost no association between what it costs a consumer for getting healthcare benefits and what the consumer personally pays for those healthcare benefits. As Phil Gramm said in a recent debate, "If I bought groceries the way I buy healthcare, where somebody else pays 95 cents out of every dollar of food I buy, I’d eat really well... and so would my dog." The point here is that the subsidy to healthcare benefits is part of the government tax wedge that has been driven between wages paid and wages received. Healthcare is only one example of the rapid expansion of the tax wedge.
Over the past five years the government tax wedge has grown dramatically. In order to recoup the job losses of the past five years, the tax wedge has to be reduced equally dramatically. Gimmicks like the Fed’s quantitative easing as contained in QE1, QE2 and "Operation Twist" don’t do anything to reduce the tax wedge or increase employment. The stimulus packages of the past five years only make the wedge greater and employment worse. These stimulus funds were used to pay people not to work, bail out failing companies, and fund wasteful projects.
If we’re going to get serious about meaningful job creation, we’ll have to make work more profitable to employers
and more attractive to workers. Spending cuts, low rate flatter taxes, deregulation, freer trade and sound money are the answers. The five dicta of a prosperous economy are:
- A low rate flat tax:
A la Jerry Brown’s flat tax when he ran for president in 1992.
- Spending control:
A balanced budget amendment whereby spending is restricted by tax receipts without raising tax rates. In other words, if government raises spending on one product it must also reduce government spending on another product. Increasing government spending with a deficit in mind or by raising tax rates as a consequence doesn’t make sense today.
- Sound money:
The Fed should restrict the supply of money, thereby making money valuable. The Fed should do what Paul Volcker did in 1979 to make the dollar once again as good as gold, and then people will hold dollars rather than gold.
The least impediments to the free flow of goods and services across national boundaries is the key to good foreign economic policy. Ratify free trade agreements with Korea, Panama, Columbia, and aggressively pursue other free trade agreements. Get rid of "buy America" provisions as contained in the stimulus packages, and allow Mexican trucks to drive in the U.S. as part of NAFTA.
- Regulatory reform:
Everyone understands the need for regulations; you can’t choose every morning which side of the road you drive on. But you want regulations, restrictions and requirements to be directly focused on the issue at hand and not to overreach, not to go beyond their purpose and do collateral damage to the economy. Regulations should be reasonable, focused and direct, but not too broad.
As policy is proposed on the campaign trail and made in Washington, pay close attention to how the changes will affect the government tax and expenditure wedge. The only way you’ll see a marked, sustainable decrease in unemployment
is if the wedge is reduced.