Unemployment and "Fundamental" Tax Reform

09/09/2013 10:06 am ET | Updated Nov 09, 2013

When Congress comes back next week, Washington will increasingly focus on what it calls "fundamental" tax reform. But it won't be entertaining reform capable of fundamentally shifting employment patterns and generating the jobs we need.

Meanwhile, employment continues to take one step forward and two steps back. Today's jobs report drops the official unemployment rate to 7.3%, but that's largely due to workforce shrinkage. In August the economy added 169,000 jobs, but 312,000 gave up looking and dropped out of the workforce. Another 74,000 jobs were subtracted due to overestimation in the previous two reports. Long-term unemployment is up; wage growth is down. Many new jobs are part-time, taken by workers who want but can't find full time jobs. Many are in service sectors with the lowest-pay and fewest working hours.

Over the past year we generated 1.6 million jobs -- not enough to keep pace with population growth, let alone make a real dent in unemployment. The number of officially recognized unemployed is currently 11.3 million, but that's just the tip of the iceberg. Of the potential workforce of about 243.5 million noninstitutionalized adults, only 63.2% are working - a 35-year low. The other 36.8% -- over 100 million people-- are jobless.

They're the economy's greatest untapped resource. Some of them may not want to work, but to provide opportunities to all those who do, we'd have to generate about 80 million full-time-equivalent jobs. We won't do that at a rate of 1.6 million jobs a year.

This is a fundamental, structural disconnect requiring a fundamental, structural solution. Incremental improvements in official unemployment, which may come in the months ahead, or incremental policy reforms, won't change the fact that our anemic job creation is out of scale with our massive joblessness.

Before the August recess, President Obama proposed a "grand bargain" of making corporate tax changes, generating short-term revenue and spending it on "significant investment in creating middle-class jobs" (such as education, training and infrastructure projects). It was immediately rejected by most Republicans. But the tragedy for the economy is not that it won't pass. It's that like so many other trial balloons floated by both parties, it represents the same, old half-measures for stimulating employment, and even if it did pass, it could only generate a tiny fraction of the jobs we need.

To address unemployment at the eight- or nine-figure scale of the problem, we need to think bigger and deeper. Just as Depression-era policy was constrained by the old gold standard, current economic policy is constrained by hidebound thinking and untenable assumptions which we'll have to overturn before we can move forward.

A big one is that the economy can thrive or government budgets can balance when employment is officially 6% or 7%, but 40% of Americans who could work can't find jobs, most of them being dependents whose costs society and government must pay. Another is that we can afford to discard the potential contributions of chronically underemployed constituencies -- seniors (two thirds of whom used to work in the 1950s, now it's below 15%), youth, women, people of color, people with disabilities, legal immigrants, etc.

Once we're free of those assumptions, and adopt the premise that the economy can and should provide opportunity for all Americans who want jobs, a new framework with viable policy solutions will open up. We'll realize that many decades of high payroll taxes have artificially hamstrung the job market, hiking the cost of labor 17%, and effectively subsidizing non-labor production factors (materials, energy, land). With the relative pricing of employing people vs. using up things distorted by up to 30%, labor is underutilized and tens of millions of potential workers are sidelined, while energy and other resources are overexploited in destructive and wasteful ways.

Payroll taxes are the biggest tax most American workers pay. They raised about $850 billion or 35% of the federal budget last year (revenues will be even higher this year since the 2 percentage point payroll tax cut expired in 2013) by raising hiring costs and holding job growth down. Phasing them out, and replacing the revenue by phasing in taxes and closing loopholes on wasteful energy and resource consumption, wouldn't raise net taxes or deficits one penny. But it would end the distortion in relative prices of employing people vs. consuming things, lift labor demand, accelerate economic growth and generate up to 40 million full-time equivalent jobs.

That would sharply cut massive government and social costs associated with joblessness. If payroll tax cuts were offset by energy taxes (e.g., cut the oil depletion allowance, tax wasteful appliances, institute carbon fees or taxes) it would incentivize energy independence, efficient resource use and innovation. We'd have a larger, more efficient, faster-growing economy with fewer costs and less debt.

That would be genuinely "fundamental" reform.