Wednesday, October 16, 2013

Aging, Taxes, and the State of the Labor Market

Copyright, The New York Times Company

As people age each year, that tends to increase average ages. At the same time elderly people die and babies are born, and that tends to decrease average ages. The combination of these two forces can keep the average population age constant over time.

The baby boom from the late 1940s to early 1960s changed this calculus, because the number of babies born in those years was well above normal. Average ages fell when the baby boomers were born, and have risen thereafter because the baby boomers’ birthdays tended to outweigh the arrival of subsequent birth cohorts.

For decades, people tended to reduce the amount they worked – especially through retirement – as they reached 62 and beyond, because their health declined, they became eligible for Social Security, they wanted to spend time traveling or they looked forward to extra time with grandchildren. Still, retirement behavior need not reduce total workers per capita because people turning 62 can be replaced by young people coming into the work force.

In about 2008, the first baby boomers started to reach normal retirement ages. Their numbers are so large that the people coming out of school are too few to fully replace them. This historically unusual rate of population aging is expected to reduce employment per capita.

You might say that the natural rate of employment has been falling in recent years, for labor supply reasons that have nothing to do with the recession, financial crises and other economic events.

For this reason, in my book and elsewhere I look at labor time series that are adjusted for population aging. The chart of work hours per person below is an example. The chart is on an index scale, with the last month before the recession normalized to 100. An index value of, say, 90, means that hours per person were 90 percent of what they were in December 2007: a drop of 10 percent.

Calculated with data from the Bureau of Labor Statistics, the Census Bureau and the Bureau of Economic Analysis

The red series shows that, without any adjustment, the labor market is still about 6 percent below what it was: less than half recovered from its 10 percent drop. But the recovery is more significant if we adjust for age: the gray series had reached 96.3 by August 2013.

In other words, two of the six percentage points of the current depression of the red series is a consequence of population aging between 2007 and 2013. Because the Federal Reserve and other policy makers cannot stop the aging process and the labor supply shifts that go with it, they should understand that their job of helping recovery will be finished before the red series gets back to 100.

Economists disagree about many things, but they seem to agree with the basic idea that the lack of recovery is partly attributable to population aging, and that policy makers cannot stop the aging process. Paul Krugman, for example, notes that we need to adjust for demographics. He uses a slightly different adjustment, but his measure and mine agree that population aging by itself depresses the usual labor market indicators by 1 or 2 percent.

But aging is not the only change affecting labor supply. Marginal tax rates have increased five percentage points since 2007 and will increase another five percentage points over the next 15 months, a trend attributed especially to expansions in health and other safety net programs. By 2015, a typical worker will keep only half of the value created by employment, compared with 60 percent kept before the recession.

Economists have traditionally recognized that a 17 percent reduction in the reward to working (from keeping 60 to keeping 50) would significantly contract the labor market, and do so at least as much as the 2 percent that the aging of the baby boom does. Yet this time many economists are reluctant to acknowledge marginal tax rate increases, even though marginal tax rates affect labor supply in many of the same ways that aging does.

Perhaps the economists who are silent about marginal tax rate hikes are worried that acknowledging the new rates would overshadow their well-intentioned origins: helping the poor, the unemployed and people without health insurance.

Professor Krugman, for example, says life is too short for him to look closely at my criticism and at the marginal tax rates I’ve measured, and doesn’t indicate that he’s looking at anyone else’s measures either. He’s not the only one: I have visited several Federal Reserve banks since 2009, and hardly any of the economists there seemed to be aware of what’s happening to marginal tax rates.

The Federal Reserve cannot reverse the tax rate increases any more than they can reverse the aging process. Perhaps Congress should ask Janet Yellen, nominated as chairwoman of the Federal Reserve, what she knows about changes in tax and retirement rates, and what they say about the future of the labor market.

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