Making More Unemployed than Employed

By adding significantly to benefits for unemployed people without commensurate additions to the incomes of workers, the 2009 American Reinvestment and Recovery Act (a.k.a., "stimulus law") changed 100 percent taxation from a rare circumstance to one that presented itself to about five million household heads and spouses. If Congress had heeded the advice of those calling for a "bigger stimulus," as many as 13 million people would have made more unemployed than they would as workers. Watch this 19 min video to see how such high implicit tax rates became reality.

Viewers interested in more information on this topic: please look at http://www.nber.org/papers/w18591

It happens in Japan too (ht Austen Bannan).

Welfare Arithmetic Event Tomorrow

***EVENT TOMORROW***   American Action Forum Event Will Examine Stimulus Spending Effects on Welfare Efficacy   Speakers Include Jared Bernstein, Center on Budget and Policy Priorities; Casey Mulligan, University of Chicago; Shannon Mok, Congressional Budget Office   WASHINGTON - The American Action Forum (@AAF) will host an event tomorrow, Wednesday, January 23 examining the link between stimulus spending and welfare efficacy. University of Chicago Professor Casey Mulligan will first present findings from his recent paper, “The ARRA: Some Unpleasant Welfare Arithmetic.”  Following the presentation, AAF’s Director of Fiscal Policy, Gordon Gray, will moderate a discussion on the paper’s implications between Jared Bernstein of the Center on Budget and Policy Priorities and key contributor to the design of The ARRA and Shannon Mok of the Congressional Budget Office and lead author of a recent CBO report on effective marginal tax rates on low and middle income workers. RSVP here. Watch live online here.   WHEN: Wednesday, January 23th from 9:00AM – 10:30AM   WHAT: Getting Employment Incentives Right: ARRA and Marginal Effective Tax Rates   WHERE:   National Press Club, Holeman Lounge 529 14th Street Northwest Washington, DC 20045 RSVP: http://arra.eventbrite.com/# LIVE STREAM: http://www.visualwebcaster.com/event.asp?id=91799   AGENDA   8:30 AM: Doors open, breakfast will be served   9:00 AM Presentation: “The ARRA: Some Unpleasant Welfare Arithmetic”   Casey Mulligan, University of Chicago   Discussants:   Jared Bernstein, Center on Budget and Policy Priorities Shannon Mok, Congressional Budget Office   Panel discussion will include time for audience questions.   Moderator:   Gordon Gray, American Action Forum   10:30 AM Conclusion For press inquiries, contact Noelle Clemente at nclemete@americanactionforum.org or 240-888-7310.

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Pre-order your copies of The Redistribution Recession

In the next several days I will be reviewing the page proofs of my forthcoming book The Redistribution Recession.

You can pre-order a hard cover version with color charts, including shipping, for less than $35!! That's so cheap that you'll want to order one for home and another for the office.

Amazon.com

Barnes and Noble

Redistribution, or subsidies and regulations intended to help the poor, unemployed, and financially distressed, have changed in many ways since the onset of the recent financial crisis. The unemployed, for instance, can collect benefits longer and can receive bonuses, health subsidies, and tax deductions, and millions more people have became eligible for food stamps.

Economist Casey B. Mulligan argues that while many of these changes were intended to help people endure economic events and boost the economy, they had the unintended consequence of deepening-if not causing-the recession. By dulling incentives for people to maintain their own living standards, redistribution created employment losses according to age, skill, and family composition. Mulligan explains how elevated tax rates and binding minimum-wage laws reduced labor usage, consumption, and investment, and how they increased labor productivity. He points to entire industries that slashed payrolls while experiencing little or no decline in production or revenue, documenting the disconnect between employment and production that occurred during the recession. The book provides an authoritative, comprehensive economic analysis of the marginal tax rates implicit in public and private sector subsidy programs, and uses quantitative measures of incentives to work and their changes over time since 2007 to illustrate production and employment patterns. It reveals the startling amount of work incentives eroded by the labyrinth of new and existing social safety net program rules, and, using prior results from labor economics and public finance, estimates that the labor market contracted two to three times more than it would have if redistribution policies had remained constant.

In The Redistribution Recession, Casey B. Mulligan offers hard evidence to contradict the notion that work incentives suddenly stop mattering during a recession or when interest rates approach zero, and offers groundbreaking interpretations and precise explanations of the interplay between unemployment and financial markets.

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I understand that physical copies are scheduled to ship from the press' warehouse on October 4 ... a week or two after that, the book should be available for immediate purchase.

Sweden Made Work More Attractive than Unemployment

Professor Sauer at thesportseconomist.com sent me this, which he found at Stefan Karlsson's blog:

“In Sweden, the centre-right government elected in 2006 has implemented significant income tax reductions (and payroll tax reductions), particularly for low earners while at the same time, unemployment and sick leave benefits have been cut and it has become much more difficult to be able to receive such benefits.

In Denmark, by contrast, even though it too has a formally "centre-right government" it has largely refrained from reducing taxes or government hand-outs, and it has more specifically lacked the focus of their Swedish counterparts in strengthening incentives to work by reducing unemployment benefits and taxation of low income earners.”

Denmark’s employment has fallen 5% in the past year while Sweden’s is unchanged.

CBM: I am embarrassed to report having been too busy in this recession to give much attention to the details of European recessions, but I did make one comparison of European countries that included Sweden (with a 2 percent employment gain over 7 quarters) but did not include Denmark due to lack of GDP data. The same employment data show a -0.6 percent employment loss for Denmark. However, the theme of my article was that countries that allowed employment to adjust downward may, remarkably, enjoy MORE GDP as a result.



Determining whether my article's suggestion is correct, and whether that logic has much to say about the Denmark-Sweden comparison, requires further research.

Estimates of How Much Unemployment is Due to UI Expansion

Dr. Feroli at JPMorgan: extended benefits account for 1.5 percentage points of the current unemployment rate

Professor Robert Shimer: all benefits account for 1 - 1.5 percentage points of the current unemployment rate

Federal Reserve Board: "The several extensions of emergency unemployment benefits appear to have raised the measured unemployment rate" (Jan 2010 FOMC minutes). They cite other estimates, which could overlap with the above.

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UPDATE: Econbrowser claims that raising the unemployment rate might enhance welfare -- for a more detailed discussion of that remarkable claim, see this short post.

For my own decomposition of the "offsetting" effects of UI, see this post from last summer.

I am well aware that the Meyer study and the study of Pittsburgh are "partial equilibrium" -- in theory it is conceivable that one person's work behavior is offset (or more than offset) by the work decisions of others. Indeed, I have given a great deal of attention to empirically estimating the feedback effect, and found (in this paper, this post, and the posts linked therein) that an increase in labor supply of one group is not fully offset by decreases in labor demand for other groups, but rather increases aggregate labor usage (as partial equilibrium theory would predict).

Although a bunch of economists proclaim that UI's general equilibrium effect offsets its partial equilibrium effect, they have put forward zero evidence in support.

Do Jobless Benefits Discourage People From Taking Jobs During a Recession?

Copyright, The New York Times Company

Unemployment benefits provide a small amount of help to a number of people who desperately need it. But some economists have gone too far by claiming that unemployment insurance is stimulating the economy.

Unemployment insurance is jointly administered and financed by the federal and state governments, offering funds to “covered” people who lost their jobs and have as yet been unable to find and start a new job. The program has been around for decades, but this recession has created an especially large group of laid-off workers who, despite an extensive search, genuinely cannot find another job.

With no new job in sight, a large group of people are under considerable personal and financial stress. In recognition of these facts, the “stimulus” law of 2009 extended the eligibility period for unemployment benefits, and provided additional funds for the program.

Before this recession, most economists probably thought that some amount of unemployment benefits were just and compassionate, and offered a sense of security even to people who were lucky enough to retain their jobs, despite the fact that the program would raise unemployment rates and reduce both employment and economic output.

In other words, unemployment benefits shrink the economy to some degree, but shrinking the economy a bit may be a price worth paying.

Unemployment benefits were thought to reduce employment and output because, by definition, working people were ineligible for the benefits. In particular, an unemployed person who finds and starts a new job, or returns to working at his previous job, is supposed to give up his unemployment benefits. Economists had found that a large fraction of unemployed people delay going back to work solely because the unemployment insurance program was paying them for not working.

Fewer people working means a lower employment rate, and less output because unemployed people are not yet contributing to production.

The recession has seen a number of economists ignore prior findings on unemployment insurance, at least as long as this recession continues. For example, in evaluating the stimulus law economists at the nonpartisan Congressional Budget Office assumed that the law would raise gross domestic product, and took no account of the fact that the unemployment insurance and other provisions of the stimulus law give people incentives to work less.

Paul Krugman recently summarized the incentives-do-not-matter point of view in his blog (see also a leading labor economist at Harvard, quoted here):

Everyone agrees that really generous unemployment benefits, by reducing the incentive to seek jobs, can raise the [normal unemployment rate]… But in case you haven’t noticed … What’s limiting employment now is lack of demand for the things workers produce. Their incentives to seek work are, for now, irrelevant. [emphasis added]

I have not seen any evidence to support this claim that, in essence, the laws of economics are suspended as long as a recession continues. Rather, the available evidence suggests the opposite.

One feature of the unemployment insurance program is that it specifies an exhaustion date: a person stops receiving benefits when he or she starts working again, or reaches the exhaustion date (often a fixed number of weeks after being laid off), whichever comes first.

In the past, economists observed that a large fraction of unemployed people suddenly started working again within a week or so of their exhaustion date, despite having been without work for so many weeks prior: evidence that the benefits themselves were sustaining unemployment.

If the Congressional Budget Office, Professor Krugman and others were correct, this pattern would be absent during a recession, because the demand just isn’t there, and demand will not miraculously appear merely because of the arrival of the benefit exhaustion date.

A study published by two labor economists, Štepan Jurajda and Frederick J. Tannery, looked at employment histories for unemployment insurance recipients in Pittsburgh in the early 1980s. Unemployment rates got quite high in Pittsburgh in those days, reaching 16 percent at one point, and staying over 10 percent for two and a half years.

The chart below summarizes their findings for Pittsburgh.

The chart displays the fraction of persons (in Pittsburgh) receiving unemployment benefits who began working again, as a function of the number of weeks until their unemployment benefits were scheduled to be exhausted. For example, a “hazard” value of “0.04″ for week “-14″ means that, among unemployed persons with 14 weeks remaining until their benefit exhaustion date, 4 percent of them either began working a new job or returned to their previous job.

Very few people started working during the two to three weeks prior to the exhaustion of their unemployment benefits (weeks “-3″ and “-2″ in the chart). But almost 30 percent started work just a week later (19 percent started a new job, 10 percent returned to a previous job).

“Demand” may have been lacking in Pittsburgh in the early 1980s, but that did not stop unemployed people from responding to the work incentives presented to them by the unemployment insurance program (economists also looked for this pattern during a Swedish recession, and found it there too).

Unemployment insurance is only a small part of the reason why the labor market has so far failed to restore employment to pre-recession levels. But unemployment insurance is not free: It results in less employment and less output, not more. The real question is whether, and for how long, this price is worth paying to continue a just and compassionate program.

Flashback: Straw Man

Last year I was told that "incentives do not matter" is a "straw man." -- that nobody actually believes this, so that my raising the issue was just rhetorical smoke and mirrors rather than a rebuttal of a real-live argument.

As recently as yesterday, you could read this:

"Everyone agrees that really generous unemployment benefits, by reducing the incentive to seek jobs, can raise the NAIRU ... But in case you haven’t noticed ... What’s limiting employment now is lack of demand for the things workers produce. Their incentives to seek work are, for now, irrelevant. [emphasis added]"

And it's not just one guy. One of the world's leading labor economists was quoted as saying "Traditionally, many economists have been leery of prolonged unemployment benefits because they can reduce the incentive to seek work. But that should not be a concern now because jobs remain so scarce," and mention of incentives like these was conspicuously absent from his testimony to Congress on what's going on in the labor market. (If you think it's just two guys, look here and here).

As often as I see this claim, and how critical it is to evaluating public policy, I never see any evidence cited to support it. Meanwhile, contradictory evidence is easy to find, even during recessions. There are two types of evidence:

(a) When a group of people is suddenly presented, during a recession, with different incentives to earn, that group suddenly changes its work and earning behavior. Last week I displayed a striking chart on unemployment duration in Pittsburgh during the early 1980s recession, when unemployment was higher than it is now, and stayed that way for years. Last summer I wrote about teenagers who are much more likely seek work when school lets out for summer. Tino pointed me to a paper about the Swedish unemployment system, which became less generous during a Swedish recession (I call it a recession because unemployment had surged and surpassed 9 percent).

(b) Such groups do not merely switch places with other groups, but rather their behavior affects aggregate employment. I have shown how this worked in the summer of 2009, and for the first 12 months of this recession in the building industry.

See also "The Laws of Economics have Been Suspended!"

What Does Aid to States Do To Marginal Tax Rates?

Suppose that the federal government gives $ to the states in a way that give states incentives to match the federal spending with more of their own spending. Then the federal grant would increase state-level taxation (presumably some combination of present and future taxation), and thereby raise nationwide marginal tax rates beyond that occurring due to the fact that the federal government eventually has to pay for federal spending with federal taxes. And this does not even could "implicit" marginal tax rates created by any tendency of states to spend more on low income persons and businesses.

If the federal government gives fungible $ to states, then the states could react either by cutting current state taxes (or increasing them less), cutting future state taxes (even states with balanced budget amendments could do this by adjusting their capital expenditures), or increasing spending.

The Obama White House estimated that 1/3 of fungible federal $ to states goes to state tax cuts, and the other 2/3 to increased spending -- a pretty good estimate IMO. The tax cuts do not necessarily have to be in the present, and do not necessarily have to reduce marginal tax rates (e.g., some of the recent federal "tax cuts" increased income-weighted marginal tax rates). The increased spending itself is very likely to raise marginal tax rates.

Thus, the effect of aid to states is probably a lot like the average federal stimulus dollar spent on other things, which raises marginal tax rates and thereby reduces GDP.

"Stimulus Law" Reduces Supply: Food Stamp Edition

Another part of the "Stimulus" law spends $21 billion increasing food stamp spending.

It is well known that the food stamp program acts as an implicit tax on earning, because fewer food stamp benefits are awarded to people who earn more.

This paper (Appendices B & C) calculates some marginal tax rates as a function of income, which I have translated into economy-wide average marginal tax rates from food stamps for the program BEFORE the stimulus law (the average includes zero marginal tax rates for the large number of people not eligible):

person-weighted average marginal tax rate (pre-stimulus): 4.1%
income-weighted average marginal tax rate (pre-stimulus): 1.1%

The stimulus increased the food stamp budget by 13 percent, so impact of the stimulus was to increase marginal tax rates from the food stamp program by:

0.5 percentage points (person-weighted)
0.1 percentage points (income-weighted)

The impact may seem small, but this is just a sliver of the stimulus law. If the rest of the stimulus ($766 billion in addition to the $21 billion on food stamps) were offering the same kind of incentives, the overall impact on marginal tax rates would be:

19.9 percentage points (person-weighted)
5.6 percentage points (income-weighted)

In case you think that adding 20 percentage points to marginal tax rate would not reduce employment during a recession, take a look here.

Does "Making Work Pay" Actually Make Work Pay, or Raise GDP?

The "Stimulus" law's single most expensive provision was "Making Work Pay". It is a $400 tax credit to persons with ANNUAL earnings in between $6452 and $75000, and lesser amounts for persons earning outside the range (reaching zero at $0 and $95000).

So this provision does encourage people to earn somewhere in between $6452 and $75000, rather than earning outside the range. In order to understand how that relates to "making work pay", we need to know whether it does more to pull incomes down into that range from above, as opposed to pushing them up from below.

THE NATIONAL EMPLOYMENT RATE
One question is how many people earn zero for the year, but are on the margin for working. This is difficult to know exactly but, for example, the 2009 CPS demographic supplement says that 10 percent of men aged 25-54 in 2008 earned zero that year. Only 3 percent of men and women aged 25-54 in the labor force (but not necessarily working) in March 2009 had zero earnings for 2008. So let's say that the number of persons who might consider changing their annual earnings from zero to a positive amount is equal to 5 percent of the labor force, or about 7.8 million people.

Another 20.5 million people had earnings between 0 and $6452 for calendar 2008. So we have a total of about 28 million people encourage to work, or work more.

8.4 million people earned between $75K and $95K in calendar 2008.

So clearly there are more people induced to earn more rather than less, and we can conclude that "making work pay" did push in the direction of raising the national employment rate (how much is a much more complicated question).

GDP
Note that the types of people encouraged to work more are different than the types of people encourage to work less, so it is possible that "making work pay" could reduce GDP even while it raises national employment.

The 8.4 million people earning $75K and $95K in calendar 2008 had an average income of $83K, as compared to $3K for those 20 million earning $1-6452 (who knows what the 7.8 million who earned zero would have earned if they had worked). Obviously, $400 seems like more to the latter group, and therefore would tend to motivate a greater change in hours or weeks worked for them: a rough adjustment for this compares the marginal tax rates for the two groups. The former group's marginal tax rate was 2% (ie, they lost $20 of tax credit for every $1000 they earned), and the latter group's was -6.2% (they gained 62 dollars of credit for every $1000 they earned).

So the income-weighted average marginal tax rate for the two groups was (8.4*83*.02 - 28*3*.062)/(8.4*83+28*3)= +1.1 percent. In other words, on net Making Work Pay probably REDUCED the supply of income, because its income-weighted average marginal tax rate was positive, rather than negative.

SUMMARY
In summary, a good guess says that "Making Work Pay" may have increased national employment and hours, but it is highly unlikely that it increased GDP. The Treasury cost of the program was not only the $116 billion budgeted, but also the loss of other tax revenues due to the net disincentive to earn.