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The Only Way to Fix the Deficit: Multiply Jobs

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Last week, two tightly connected, but separately reported, headline stories broke. Wednesday the Bowles-Simpson commission issued its report with proposals for shrinking the federal deficit, which include cutting federal spending and certain tax rates while raising payroll taxes. Friday morning, as the commissioners were voting on the report, the dismal November jobs report came out. It revealed unemployment is not falling, but sustained and rising from 9.6 to 9.8 percent -- the longest streak above 9% unemployment on record. The Commissioners gave it 11 out of their 18 votes, three votes shy of the mark that would have gotten Congress to take it up.

Job creation got an honorable mention but no real priority or substantive policy focus in the deficit commission's recommendations. The new unemployment numbers illustrate why this was a mistake, both politically and fiscally. It's true that we can't tolerate high deficits much longer. But neither can we tolerate sustained 10% unemployment and risk long-term, self-reinforcing, structural decline of our labor force and economy. It's time to tackle both issues -- the massive federal deficit, and massive unemployment -- together.

One central and oddly repressed fact in our discourse on controlling the deficit, is that the two goals are not mutually exclusive; they're deeply interdependent. Mounting a massive jobs stimulus effort won't increase the deficit -- on the contrary, we can't close the deficit without one. During the Clinton administration we went from a $290 billion deficit in 1992 to a $239 billion surplus in 2000 while creating over 20 million private sector jobs. That's no coincidence; job creation and deficit reduction are inextricably linked. Higher employment increases the tax base and business profits so revenues go up, while expenditures on unemployment and other government dependency costs go down. Debt service also shrinks as a result.

The cumulative budget effects are huge. The Congressional Budget Office for many years tracked the potential impact of job growth on projected deficits, though it has apparently ceased doing so. But in 1995 it projected that just a one percent increase in employment would cut the deficit by $415 billion over six years. In fact, that's roughly what happened. Now, imagine the impact on today's deficit (currently $1.29 trillion and rising fast) if we brought the unemployment rate down four percentage points to a pre-recession range of 5.5 - 6%.

That would argue that a massive jobs program, if it worked, would be worthwhile even if it cost hundreds of billions. But in fact, it need not cost anything. We can have a "free," budget-neutral jobs stimulus if we shift the current tax burden. We don't have to increase net taxes to close the deficit, or for that matter, decrease them to create jobs. We simply have to change the distribution of what is taxed. Right now, one of the chief things we tax to fund the federal budget is jobs.

Payroll taxation is currently vying with income tax as the top federal revenue raiser (this chart shows it accounted for 42% of federal revenue in 2009, while income tax accounted for 43%). It is the largest tax 80% of Americans pay, and the most regressive. It kills jobs by inflating hiring costs over 15% and effectively subsidizing non-labor production factors - energy, materials, land -- by an equivalent amount. That's a whopping, perverse 30+% price signal giving business an incentive to be materials/energy/land/technology intensive but to avoid using labor.

This is a colossal mistake and a deep-seated, long-standing, fundamental problem for the economy, artificially depressing employment for decades. As I argued in a previous post, unemployment is much, much higher than official rates suggest, because the official rates arbitrarily and progressively define millions of Americans out of the workforce to keep unemployment looking lower than it actually is. Chronically under- and unemployed women, people of color, seniors, youth, people with disabilities, legal immigrants and others are not counted as unemployed by the Bureau of Labor Statistics. BLS numbers indicate 15 million Americans are officially unemployed, but that's a small fraction of the number of Americans who would be working given the opportunity, but aren't. The country would have to create a total of 80 million full-time jobs to give everyone who would like to work that chance.

But this mistake is correctable with a strategy called payroll tax shifting. If we cut payroll taxes, and started taxing inefficient use of non-labor items by an equivalent amount (for example via a non-labor VAT tax, carbon pricing fees or energy inefficiency taxes and/or any combination of many such available alternatives that could raise the revenue that we now get from taxing payrolls), we would reverse the distortion in labor costs, disincentivize wasteful consumption of things, reincentivize hiring of people, and create tens of millions of jobs.

The Bowles-Simpson deficit report and the debate that will follow in its wake represent an important moment for coming to grips with our deep economic problems and considering this kind of fundamental tax reform. Indeed the report proposed fundamental reforms, slashing income and corporate tax rates along with spending. But it chose not only to keep payroll taxes, but actually to increase them through raising eligibility ceilings. That would only make our jobs dilemma worse, which ultimately will worsen the deficit.

One of the report's bright spots was a new recommendation that Congress consider a proposal from the previous Domenici-Rivlin deficit task force report, "Restoring America's Future," for a one-year payroll tax holiday to stimulute job growth. That's another indicator of growing support for the idea of cutting payroll taxes to generate jobs, but it's a short-term, token gesture compared to the fundamental game-changer we need. A one-year uptick in the perennial business cycle won't fix our problems; we need structural reform.

As Alton E. Drew recently wrote in a blog about the Bowles-Simpson proposals' effect on African American unemployment:

"While the co-chairs' draft speaks to increasing some taxes and cutting unnecessary entitlement programs, it barely speaks if at all to the apparent structural unemployment gripping the nation."

As the Domenici-Rivlin report itself states:

"Some politicians and economists present a false choice: reduce unemployment or stabilize the debt. Restoring America's Future, however, requires that we do both -- and begin now."

If we're serious about stabilizing our debt, speaking to the structural unemployment gripping the nation and improving long-term growth, we'll use this important political juncture to spotlight payroll tax shifting as a thoroughgoing solution to our fundamental problems. The politics of fundamental reform are always difficult, but the politics of half-measures will prove impossible.