Saturday, January 25, 2003

Full Employment and Tax Cuts-"This is your Saturday Night All Request Oldies Show on WDRB, Dr. B radio. Just call our toll-free request line at 888-ECON-R-US. We've got a call in from Marc in North Carolina looking for an oldie from 1967 from that great girl band Gal Breath; Spinout At Phillips Curve." Sorry for the poetic license. Spudlets want me to look at ways to promote full employment, bouncing off this Tech Central piece from Arnold Kling (who seems to be a supply-side Keynesian) on Israeli and American unemployment.
As a card-carrying saltwater Keynesian, I believe that sometimes the causes of unemployment can lie with the demand side. Take the United States economy today, for example. As Brad DeLong points out, productivity is going through the roof. From a supply-side perspective, our economic engine is purring like a kitten. As Brad puts it, "The only dark lining inside this silver cloud is that faster productivity growth means faster potential output growth and a widening gap between output and potential."
I don't know where you get your Supply-Side membership card, but I also believe that sometimes the causes of unemployment can lie with the demand side. If productivity is growing faster than the demand for products, you will tend to have unemployment until the economic system figures out what to do with the excess labor. One can put that extra labor to use by either expanding demand for existing products being made more efficiently or by creating new products not currently being demanded. Expanding demand can be done from a fiscal policy basis by either cutting taxes or raising spending. Keynesians like spending because a tax cut will be partly saved and partly spent. However, Keynesians (but maybe not Kling) tend to ignore the effects of cutting taxes on supply. Cutting taxes will help increase supply in the long run, as people are more interested in working harder (more take-home pay for each extra hour worked) and saving more (for your after-tax return on investments goes up), thus stimulating the economy and adding to available capital. Thus, I'd be inclined to cut taxes in order to stimulate economic growth and job creation. If we're looking to stimulate job growth, you might look at removing the FICA tax on wage income, raising income taxes to compensate for the lost revenues. That will increase take-home pay by about 14% (assuming most of the employer's share of FICA is shared with the employee; some of it will be pocketed) and allow workers to be more willing to work at current wage levels. It will add to worker's paycheck and cut costs to employers. Kling has his own ideas
To get back to full employment and close the gap with potential GDP, I am in favor of every stimulus proposal known to man. I nominate Megan McArdle for Treasury Secretary, on a platform of abolishing the corporate income tax. The Democrats want to cut payroll taxes, too? Fine, let 'em. Money to bail out state and local governments? I'll see ya and raise ya.
I just talked about the sales tax getting cut and wouldn't mind getting rid of the corporate income tax. I'm not a big fan of revenue sharing, though, for it's not overly stimulative and lends itself to a lot of pork-barrel spending.
I am willing to incur deficits in order to get to full employment. I believe that the United States can afford to live in minus for a while, because I am exuberant about the longer-term outlook for growth, thanks to Moore's Law.
Further up in the essay, he talked about the Israeli term for personal deficit spending as being "in minus." We're not that far away from full employment, at least in the economic definition of the term of a lack of cyclical unemployment. You'll always have some seasonal unemployment, some structural unemployment (mismatches of skills and/or location) and frictional unemployment (people between jobs due to non-macroeconomic reasons, like someone who's just moved or just graduated from college), but people get worried when unemployment starts to be due to a lack of demand in the economy as a whole. A high productivity economy might result in a bit more frictional unemployment, where businesses trim payrolls because more efficient production methods allow products to be made with fewer workers. Some of those workers might be bad fits for other jobs if their skills aren't in demand elsewhere, but other workers might have salable skills that could be employed elsewhere. A combination of high frictional and structural unemployment might cause full employment to be a bit higher than in the 90s. I agree that we have a good long-term outlook for growth, but I don't think that Moore's Law (computer speeds double every 18 months or so) is going to be the engine of that growth in the '00s. We're getting to the point where computer speed isn't as much of an issue. I'm typing this at home on a Pentium II-class machine circa 1998 with a 233MhZ CPU. My 1.3GhZ laptop doesn't make me five times more productive. The problem with Moore's law is that it assumes that computers become twice as cheap every 18 months, which doesn't seem to be happening. Entry-level computers stay about the same price from year to year, but have more RAM, bigger hard drives and faster CPUs than their price counterparts of a year ago. The screamer of a year ago that was selling for double the price of the bargain machine at the time is now the bargain machine. However, you can't buy a new version of last year's bargain machine at half-price; they just don't make them anymore. When hard drives models start to drop below $100, that model gets discontinued, as does the Intel CPUs models that start to drop below $100. There's a limit to how cheap the industry will allow the parts, and thus the computers, to go. [Update 1/27 3:30PM-reader Nathan Mates points out that the figure's closer to $80 these days; I am a few years out of the loop] What is going to drive the economy are new products to add to our shopping carts. Typically, those new products will come from small upstart companies rather than existing companies. The dividend exemption isn't the best way to stimulate those companies, since young companies don't typically pay dividends. Cutting (or eliminating) the corporate income tax would help there, as it would allow firms to have more net income to plow back into new investments. What do we need to stimulate job creation? Focus on ways to encourage the creation of new products and of hiring people. We should thus focus any tax cuts on cutting payroll taxes and corporate income taxes; the combination could be sold to the US people. The dividend exemption doesn't help much since it's rewarding more mature companies that aren't big job-creators or new product-creators. I don't think the majority of this slump is demand based. Some of it is demand based, due to post-9/11 nervousness. However, the rest is either due to a depressed stock market (that lowers business investment and depresses consumer demand) and higher oil prices. The best Valentine's present for the economy is Saddam's head on a pike in downtown Baghdad; Tommy Franks can do more than Greenspan can for the economy at this point. That will take away a lot of the post-9/11 jitters, lower the price of oil and raise stock prices. Winning in Iraq coupled with a modest (not too much red ink) tax cut will bring the economy back. However, unemployment rates might stay higher than in the 90s until we get a inflow of new products that will open up people's checkbooks a bit wider. If our current market basket gets less expensive due to efficiency, we might opt to save money for the future rather than spend more on stuff we're already buying. It'll take new products to truly get the economy on a major uptick. The computer/Internet push has largely run it's course for now and another growth sector will need to emerge before we get big growth rates like the 90s.

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