The Economist: Over-Regulated America

February 21, 2012

By Michael Hendrix, Research Manager

According to The Economist, “The home of laissez-faire is being suffocated by excessive and badly written regulation.”  The point is not that America has an overwhelming amount of bad regulation, though the examples of such ill-guided red tape are numerous.  Rather, it is the cumulative effect of regulation that is chocking American free enterprise.

Dodd-Frank is a prime example.  It’s a complex bill layered on top of an already complicated industry.  ”At 848 pages, it is 23 times longer than Glass-Steagall, the reform that followed the Wall Street crash of 1929.  Worse, every other page demands that regulators fill in further detail.  Some of these clarifications are hundreds of pages long.”

Downloading the text of the Dodd-Frank bill yields a PDF file some 2,319 pages in length.  By way of comparison, our NCF Fellow Mark Perry produced a handy list of the top financial reform bills and their length:

  1. Federal Reserve Act (1913) – 31 pages.
  2. Glass-Steagall Act (1933) – 37 pages.
  3. Interstate Banking Efficiency Act (1994) – 61 pages.
  4. Gramm-Leach-Bliley Act (1999) – 145 pages.
  5. Sarbanes-Oxley Act (2002) – 66 pages.

The quantity and complexity of America’s regulatory regime not only adds a burden of cost onto the private sector but a broader sense of uncertainty (which itself is costly).  Back to the Dodd-Frank example, The Economist notes how only 93 of the 400 mandated rules have actually been issued, leaving the financial sector to comply with a law that will remain partially unknown for an equally unclear amount of time.

Dislodging America from its thicket of regulation is first a matter of reducing the number of rules.  Arcane procedures and entrenched interests means that this process won’t be easy, as The Economist shows in a follow-on article.  There’s also the danger that cuts will be imprecise and uninformed, like calling for field surgery with a machete.  This is why transparency will be vital.  Cutting regulation needn’t be as opaque as the process that made them.

Reducing red tape is a good first step.  But we must also take another look at the mindset behind the regulatory process.  Recent studies argue against the increasing specificity of rule-making in America.  Instead, if an area due for regulation is highly complex, the matching regulation ought to be decisively simple.  Dynamic, wealthy economies are necessarily complex — so the overall regulatory regime in such countries should be straightforward and highly adaptive to changing circumstances.

Put another way, a lean and simple regulatory regime is the perfect complement to a healthy economy.

On the Myth of American Decline

February 7, 2012

By Michael Hendrix, Research Manager

Is it half-time in America?  Is our country facing an inevitable decline?  Not if Clint Eastwood has anything to say about it.  Somewhere between the Star-Spangled Banner and New York’s triumph in this year’s Super Bowl, Eastwood’s gravelly voice emerged to pitch cars “imported from Detroit.”  This wasn’t any normal ad though.  Clint Eastwood was making a statement about America’s place in the world.  He said unequivocally that it’s indeed “half-time in America.”  That “people are out of work and they’re hurting too,” but “all that matters now is what’s ahead and how do we come from behind.”

Eastwood honestly couldn’t have picked a better time to make these statements.  For the past month, pundits have begun to react to those who argue that America is in decline, that our competitors are nipping at our heels, and that the world’s economic doldrums are symptomatic of a deeper systemic decline in the West.  One author in particular, Robert Kagan, took it upon himself to refute these arguments.  He may be no Eastwood, but Kagan’s voice is coming through loud and clear for all those who say, as Eastwood did, that America’s best days are ahead of it.

Is America in its twilight years?  Robert Kagan doesn’t think so.

In the eyes of Robert Kagan, the challenges that America faces today are great, but they only seem overwhelming if we forget much of American history.  It seems that every forty years brings a fresh set of concerns that appear to portend the twilight of America’s dominance.  These are not just modern concerns.  Kagan even quotes the 18th century American patriot Patrick Henry who “lamented the nation’s fall from past glory.”  Nevertheless, considering whether America is in decline is vitally important for the future of the global economy and its political order.

Those who take shots at America’s preeminence have no shortage of fodder.  The global financial crisis of 2008 not only helped precipitate economic devastation but seemed to throw into doubt the free enterprise system itself.  Our political order hasn’t fared much better amid constant evidence of political gridlock.  What’s more, all of America’s greatest efforts still can’t seem to stitch together a fractured Middle East.  Then there’s “the rise of the rest.”  Nearly simultaneous with America’s stagflation in the 1970s, a group of “Asian tigers” — South Korea, Taiwan, Hong Kong, and Taiwan — charged ahead into the elite grouping of high-income countries where their neighbor, Japan, already resided.  They were soon followed in the 1990s by the terrific economic growth of the BRIC countries: Brazil, Russia, India, and China.  Even our allies in Europe joined together to form a common economic union that could stand beside the United States in demographic and economic might.  What was once a golden age of American dominance in the 1950s seems to have become mired in a sticky swamp of faded empire.

The only problem is that the picture of American decline is incomplete at best.  Our economy may be battered, but it still stands tall with a steady 26% share of global GDP.  While I can’t defend our political system against all of its critiques, it must be said that gridlock and indecision have long been the hallmark (even the purpose) of American politics.  There’s nothing new on the Hill in that respect.  Farther afield, America’s apparent lack of influence in the Middle East today seems like a quaint notion when compared to the 1970s, when Arab nationalism blossomed into embargoes and revolution.  America’s brand image has always appeared tarnished to its detractors, even as very American brands like Pepsi thrived and thought leaders opined on our “soft power” abroad.  The truth is that there has been no golden age of unrivaled American dominance; ”the record is mixed, but it’s always been mixed.”

What is America’s place in the world?

Kagan then looks specifically at America’s geostrategic position in light of China.  America can no longer boast of its spot ahead of a pack of lesser powers.  The rise of China is great and it’s real.  China is far richer and more dynamic than the Soviet Union ever was during the height of the Cold War.  Even more so, the “Beijing Consensus” seems to resonate in a world where smaller powers yearn for the same state-driven growth and (relative) stability that China boasts.  The notion that the gravity of China’s ideas and industry would lead countries to fall into its orbit didn’t seem far-fetched back in 2004 when Joshua Ramo first articulated the finer points of the Beijing Consensus.  Except that we haven’t really seen that occur.  As Michael Beckley points out, “China’s growth rates are high because its starting point was low. China is rising, but it is not catching up.”  Furthermore, there isn’t what one could call a Chinese sphere of influence outside of the Shanghai Cooperation Organization and assorted trade links on the Malay Peninsula and in Africa.  America’s greatest rising competitor reaches about as far as its checkbook can go.  China’s geostrategic position is quite difficult too, especially in light of the American influence that surrounds the country on nearly every side, from our giant base in Okinawa to our friendship with burgeoning India.

Even if America boasts an enviable spot in the world, what of our country’s capacity and capability to operate in a world full of emerging powers?  Some speak of imperial overstretch — even hubris — in a time of yawning budget deficits.  Kagan’s reply is deceptively simple: Abandoning our global presence will cost us far more than we will ever save by abandoning our commitments abroad.  What is more, America’s military forces represent an ever smaller fraction of our total population, while our military’s budget is still far below its point throughout much of the Cold War.

Decline isn’t inevitable

To Kagan, the real concern is the infectious notion that America’s decline is somehow inevitable.  Rather, there’s much in our nation’s history to show that even in our darkest hours we are a resilient and resourceful people.  Many emerging countries will continue their rise, sometimes to greatness.  By their incorporation into a global network of trade and institutions, together with America’s continued support of the world order that it helped create, a growing world can be seen as the ultimate win-win.  America will emerge absolutely stronger as others grow in a relative sense.

Three specific trends portend America’s continued dominance.  First, America’s total debt is declining as a share of GDP.  Ken Rogoff’s This Time Is Different showed how financial crises usually saddle countries with debt deleveraging over the span of years, even decades, beyond the original crisis point.  Yet, as the McKinsey Global Institute reports, “Historical precedent suggests that US households could be as much as halfway through the deleveraging process.”  Second, our manufacturing sector is actually doing better than ever, prompting another consulting firm to declare an “American manufacturing renaissance.”  Third, the growth in shale gas and oil is combining to give America greater energy security than we’ve enjoyed for decades.

America may be down, but we’re not out.  As Clint Eastwood concluded, “Yeah, it’s half-time in America.  And our second half is about to begin.”

Embracing America’s Competitive Advantages

December 14, 2011

By Rich Cooper, Vice President, Research & Emerging Issues

The United States was built and survives on core strengths unique to our republic. Our democratic system, our capacity for innovation, our insatiable desire to challenge and explore and the diversity of our people – these are national cornerstones that give America its ever unique competitive edge. Even as other countries establish working solutions for their respective societal challenges, the United States must recognize and rely on its own strengths and put them to work answering American challenges.

Recently in The Atlantic, Frederick Hess, a resident scholar and director of education policy studies at the American Enterprise Institute (AEI), wrote about America’s enduring strengths, arguing that, “America’s ‘handicaps’ are the inevitable flip side of its unique strengths. Rather than figuring out how to undo them, we would be better served figuring out to leverage them.”

Hess wrote that these enduring strengths are America’s federalism, entrepreneurial dynamism, size, and heterogeneity. Our federal system allows our leaders to explore different approaches to complex challenges; the entrepreneurial American spirit drives the U.S. private sector; and because America is the “most racially and culturally diverse society in history,” we have access to a plethora of innovative ideas and approaches on many pressing challenges.  For as accomplished and unique as the nations of today may be and for as legendary and impressive as the empires of old may have been, none of them has quite the mix of ingredients as the American recipe.

While there is much about our country that can be openly questioned with its ongoing partisan gridlock and economic stagnation, the same components that made for an American century give it the exact foundation to expand technology, entrepreneurship, civil society, education, and more.  To be sure, other countries have their own success stories, built upon the circumstances and assets unique to each nation. This, however, does not mean the United States should emulate how the rest of the world answers its 21st century challenges. As Hess wrote:

“Indeed, if we look to nations that are gearing up to lead the pack in 2052, rather than 2012, we see that countries like Qatar and India are taking cues from America’s approach to solving its problems. We would be well-advised to take the hint, and to push forward by drawing on what the U.S. has always done best.”

Hess’ insights on what remains a still undefined century seems to echo words that Bill Clinton shared after being sworn in as president in 1993.  He said, “There’s nothing wrong with America that cannot be cured by what is right with America.”  For as visionary as those words may have been on a brisk January in 1993, they remind us that a foundation as unique as ours gives us strength and untapped capacity that others can only dream about.  It’s just one more reason our recovery and competitive edge is still a good bet.

Industrial Policy and Manufacturing: What’s the Big Idea?

December 5, 2011

By Michael Hendrix, Research Manager

The Aspen Institute is known for asking what I like to call “killer questions.”  Since Aspen is in the business of ideas, they know that questions have a way of focusing the mind on what we know and don’t know, spurring on that tumbling, teaming process of idea creation.  This time, Aspen’s manufacturing team (led by the esteemed Tom Duesterberg) asked in a recent event whether the U.S. needs a national manufacturing strategy.  To attempt a reply, they invited Douglas Holtz-Eakin, Ron Blackwell, and Clyde Prestowitz.

Considering the backgrounds of the individuals on stage, we in the audience got vastly differing accounts of America’s potential and what it takes to turn it into reality.  The one thing that all the panelists agreed on was that the real question was not whether America should have an industrial policy, but what form it should take.  Now, in saying this they were all taking liberties with the technical meaning of “industrial policy.”  Their point though was that even choosing to not support industry at all through the public sector was itself a policy stance.  And regardless of the policy, the end goal is the same: a healthy manufacturing sector in America.

For as differing as the panelists were, there was a lot to applaud.  In the eyes of Ron Blackwell of the AFL-CIO, competitiveness and growth are the key questions for our future. That means that America needs a pro-competition strategy rather than an explicit industrial policy.  Education and training programs are important for such an approach, as is rebuilding our national infrastructure.  This helps not just the manufacturing sector, but practically all other aspects of the economy as well.

Clyde Prestowitz, founder and president of the Economic Strategy Institute, saw a tremendous productive capacity in America that is being challenged by anti-competitive policies abroad and a domestic culture that sees manufacturing as passé.  How should a country, especially one as powerful as America, respond abroad?  As others in the Chamber here have pointed out, we “deserve the opportunity to compete—and succeed—on a level playing field.”  And while turning back the cultural tide is not an easy task, there’s much to be said for simply restoring the notion that we are a country that makes things and makes things happen.

Douglas Holtz-Eakin proved to be an insightful panelist who (in the nicest way) didn’t mince words.  He said that America was a terrible place to invest in.  Our fiscal challenges and burdensome tax structure are proving to be tremendous obstacles to investing in the future of manufacturing.  The good thing is that we know quite clearly what these hurdles are and what can be done to clear them.  The real challenge, as he illustrated later in the program regarding the space industry, is figuring out the right relationship between the public and private sector.  The private sector has the capacity in every way to lead with its investments; in turn, the two sectors must focus on coordination, cooperation, and communication (rather than control).

From here on, the panelists talked about America’s tax system, the shale gas boom, national laboratories, and more.  Though there was more disagreement to be had on the right way to keep America competitive, in a strange way the event itself was a part of gaining a sense of our national priorities.  Public policy matters for the future of manufacturing, and whatever policy decisions are made one thing is clear: the private sector must take the lead.

The Productivity Curse

October 21, 2011

By Michael Hendrix, Research Manager

Have we become too productive?  If there’s any question that seems least apt amidst the global economic downturn, it’s this one.  Yet, take a look at any chart on employment and you’re bound to worry that something larger, more fundamental is afoot.  As Bill Davidow argues in The Atlantic, skilled and unskilled alike are now strapped to the pitiless logic of a hyper-productive assembly line.  Moore’s Law famously dictated the relentless doubling of computer processing power every two years.  Technological growth is in turn making us so productive that what you and I create is becoming indistinguishable from the work of others.  The result, according to Davidow, is that our work is fast become a near commodity: useful, replaceable, and cheap.

After the worst of 2009 was past, America’s productivity carved a steep path back up to its previous heights and beyond.  Employment, on the other hand, stayed comatose (note the chart above).  Why hire more workers if a smaller number can do more than enough to meet demand?  That is the employment challenge we face today.

Davidow faced a similar situation when he used to work at Intel.  Intel was getting so good at making semiconductors – and the technology so refined – that the productivity of its workers was rising far faster than demand.  At the same time, the cost of each processor was dropping precipitously.  As a result, in Intel’s best years it still found itself having to lay off workers.  They had become “commodity workers.”

“If worker productivity is growing at an exponential rate and lots of new facilities are being built, we are at the point where commodity worker output can easily exceed the demand. If factory workers become more productive as a result of technological advances, fewer workers will be needed in each factory. When that occurs, the price for commodity work should decline, just as the price for transistors did. If this comes to pass, commodity workers will find themselves producing more and more units of output — clothes, consumer electronics, washing machines, the handling of customer questions, etc. — and being paid less and less for each one they produce.”

Knowledge workers are starting to feel like Lucille Ball on the assembly line too.

“Of course, those of us with unique skills should not be feeling too smug.  After all, a lot of what we do — answering emails, cleaning up our inboxes, following large numbers of bloggers to stay informed, and maintaining our pages on social networks — is commodity work as well.  These are all chores we have to do to stay relevant. The value of doing those commodity chores is dropping as well and so to maintain our current salary, we have to run faster as well.”

The fact that we are more capable than ever at working and that the cost of consumer goods has fallen should be very positive news – and it is.  We must consider though the brave new world we work in.  Just as companies closely examine their brand identity and the uniqueness of the products they offer in an increasingly competitive world, so should we in the labor market.  Productivity is a factor of physical and human capital as well as technology and institutions.  The answer to innovation and technological change then is to embrace it in a way that adds value to our unique work.  Only then will you and I avoid the productivity curse.

Against Declinism: Painting a Future of Long-Term Prosperity

October 7, 2011

Social demographer and urban historian Joel Kotkin joins us on our blog in his role as an NCF Fellow to offer his unique take on the state of America’s economy.

The notion of an America in decline has recently reached an apogee not seen in decades.  It has taken a deep hold of the academic establishment — never a bulwark of American optimism.  ”Declinism” has taken root even in the face of a collapsing  European Union, the alternative power long favored by academics.  Moreover, “peak oil” theorists continue to hammer away amidst one of the great energy booms in American history.  Belief in the coming dominance of China has spread itself from the corporate suite to Main Street, with nearly half of all Americans now predicting the Middle Kingdom’s eventual predominance.

Even among the patrician class — the business elite, if you will — such declinist notions are commonplace. One common call, reminiscent of the 1980s, is to abandon constitutional democracy for the kind of guided system one finds in Europe or even China.  The “down with democracy” crowd has gotten a boost from Peter Orszag, the Obama Administration’s former director of the Office of Management and Budget. Concerned with America’s inability to deal with its fiscal problems, climate change, and with rebuilding the economy, Orszag proposed shifting power from Congress and local legislatures to more “independent institutions” made up of un-elected policymakers.  Democracy, as the mandarins in Beijing would agree, can be “too much of a good thing.” Now comfortably ensconced at Citigroup, Orszag might also find the Chinese financial system, with its intersections between the state and banks, even more to his liking.

Many of these individuals have come to have a certain disdain for democracy, although these days it has more of a left-wing thrust than a right-wing bent.  William S. Dietrich, who sold his father’s Pittsburgh-based company in 1996 for a cool $146 million, has made money as an investor and recently donated $265 million to Carnegie Mellon.  He is a devoted declinist whose new book, according to a recent Carnegie Mellon bio of him, will be given the self-explanatory title, “American Recessional: The U.S. Decline and the Rise of China.”

Yet, perhaps it is too early for the English-speaking democracies to throw in the towel.  Someone should remind Mr. Dietrich that his last book, published in 1991,  was entitled In the Shadow of the Rising Sun.  Like many other books at the time, it  predicted Japanese world domination — a Pax Niponica — if the US did not undergo “fundamental institutional reform ” in the form of rule by enlightened bureaucrats.

It seems to me that the role of business is to first say that America’s preeminence is not over and then show why.  Then we can start crafting solutions that work along with our intrinsic strengths: decentralized politics, great natural resources, demographic dynamism, innovation, and entrepreneurship.  First, then, we must make the long-term case for prosperity which a solely short-term focus by business will be incapable of doing.

The Decline of American Governance?

August 29, 2011

By Michael Hendrix, Research Manager

Which country was recently ranked by the World Economic Forum as a “lowly 40th for the quality of its institutions, 54th for trust in its politicians, 68th for government waste, and a dismal 87th for its macroeconomic environment” compared to the rest of the world?  If you guessed America, you would be correct.  How did the U.S. get ranked so low?  America rightly boasts world-beating innovation and drive.  Why don’t we have effective governance to match?  To The Economist and its Schumpeter columnist, the reason comes down to two causes: institutional paralysis and economic uncertainty.

Institutional Paralysis

It’s been said that nations tend to fight yesterday’s wars.  Leaders don’t see that the rules have changed until they are in the midst of battle.  So it may be in America’s political environment.

Our political institutions have usually functioned on a fine balance between compromise and division.  The Economist argues though that something fundamental has changed in our institutional arrangement.  We are in a zero-sum, “ideological civil war.”  As each side has escalated and party ranks have been purified, “previously taboo weapons, such as the threat of default,” have been deployed.  The political parties have dug in for the next fight, and the trench line now runs through think tanks, TV studios, and town hall meetings.

To The Economist, institutional paralysis means that America isn’t keeping up with a dynamic world.  Take America’s free trade deals, for instance.  Agreements with Panama, Colombia, and South Korea are at a near standstill in Congress.  Some of these deals were concluded over five years ago.

Look at patent reform too.  Patents on everything but pharmaceuticals reap an annual profit of $4 billion while costing firms over $14 billion in litigation costs.  Here’s what Fareed Zakaria had to say in a recent column:

“Right now, a smart program to rationalize the patent process, which could unleash thousands of start-ups, is languishing in Congress not because of some principled opposition but because of turf battles between congressional committees.”

Zakaria’s solution is to “subordinate politics to a national goal of job creation.”  If The Economist is right though, his conclusion is misguided.  Zakaria must either show how today’s political stasis is fleeting or how trade deals can bypass the institutional paralysis that’s here to stay.  He does neither.

Economic Uncertainty

The greatest victim of this institutional paralysis is clearly the economy itself.  Economic fundamentals aren’t strong to begin with, yet there’s an institutional reason why companies are sitting on $1.9 trillion in cash.  Indeed, some 55% of small businesses in a recent survey by the U.S. Chamber named economic uncertainty as their greatest barrier to hiring (as it should be).  Institutional paralysis means that companies can’t predict what a government that occupies nearly 40% of the economy will do next.  That means added risk to the economy, and risk costs money.

Uncertainty isn’t new in any economy; “for all is but a woven web of guesses.”  John Maynard Keynes devoted a chapter of his General Theory to explaining how we all must invest in the face of constant uncertainty.  Moreover, academics aren’t even sure how to measure uncertainty, even for as much as the term is bandied about.  Measures of uncertainty in governance though are the most closely correlated with levels of investment, and this is where institutional paralysis rears its head again.

Rated by those who are yearning for growth and stability, America is being given a failing grade.  We are not short of aspiration or genius.  Perhaps the greatest deficit then is institutional.  Is this the brave new world of politics?

Real Solutions to the Jobs Problem

August 3, 2011

By Nick Schulz, NCF Scholar

It is tempting to think that all the nation’s economic troubles – slow growth and high unemployment – can be traced to the financial crisis and the recession that started in 2007-2008. But this would be a mistake. Some of the challenges the country faces predate the financial crisis. And understanding these challenges holds the key to getting the American jobs machine humming again.

Consider a new report by McKinsey and Company, “An Economy That Works: Job Creation and America’s Future.” The researchers at McKinsey point out that “from 2000 to 2007, employment grew by just 7 percent. In contrast, employment grew 15-25 percent in every ten-year period from 1960 to 2000, despite at least one recession in each of those decades.”

In other words, America’s jobs engine has been broken for some time. Temporary stimulus is unlikely to fix this problem.  We need to find answers elsewhere.

Jobs will be found in those sectors of the economy where demand is rising much faster than productivity. These sectors today include health care and education.  While other sectors of the economy are important and deserve our attention, these sectors are where we should expect to see robust job growth over time.

The problem is both health care and education are hamstrung by bureaucratic inefficiencies. McKinsey notes, “in some sectors, job creation is held back by outdated regulations over how services are provided and by what type of worker. For example, scope of practice laws that delineate how health care services are delivered vary across US states… Without sacrificing the quality of care, revising such laws could open the door for rapid growth of middle-skill jobs in health care.” What goes for health care goes for education, too.

Both sectors need entrepreneurs who can use the existing labor pool to push innovations and new technologies into the marketplace. But licensing and other labor market regulations make it more difficult for entrepreneurial dynamism to emerge and upend the status quo.

My colleague, the economist Arnold Kling, and I coined the term New Commanding Heights to refer to those economic sectors, like education and health care, that are emerging as key battle grounds for policymakers in the 21st century. To solve the jobs problem in the United States, we need to recognize the barriers to entrepreneurship and job creation in these, some of the fastest growing sectors of the economy. That’s the first step on the road to recovery.

License to Kill: Top Job Killers in America

October 8, 2010

By Arthur Brooks, President, American Enterprise Institute

Our politicians all seem to agree on at least one thing: There will be no recovery unless America gets back to work.

But that’s often where the agreement ends.  Once you move on to discuss how to get America back to work, opinions begin to diverge.

In general, the worst thing for job creation is a poor entrepreneurial climate.  Such a climate is brought on by the large fiscal debt, unpredictable health care costs, and a generally anti-business and pro-regulation approach by government.

In the run-up to the midterm elections, all of us should be thinking about “climate change”—about the best ways to create jobs in our nation.  We’ll hear lots of talk about recovery and stimulus, about fairness and equity, the future and change. 

As we listen to the rhetoric, remember the reality.  These are the Top job killers in America.

1. Uncertainty and business
2. Uncertainty and the consumer
3. High corporate taxes
4. Unhealthy health insurance costs
5. The threat of unionization
6. Inability to hire and fire
7. Trade restrictions
8. Credit
9. Increasing unemployment insurance

1.      Uncertainty and business
What you don’t know can (and does) hurt you.  Businesses plan around rules.  And they are unlikely to invest if they can’t be reasonably sure about what the rules will be.  When things are uncertain, businesses hold back cash to protect themselves—and this kills jobs. As my colleague Allan Meltzer has demonstrated, “High uncertainty is the enemy of investment and growth.”

2.      Uncertainty and the consumer
Uncertainty isn’t just bad for companies—it’s bad for consumers, too. If I think government policy may provoke a double dip in the economy and my job is on the line, there’s no way I’m going out to buy a new car.  For that matter, even the possibility of a huge gas tax would make me less likely to make a car purchase decision. All this kills jobs.
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HED: Simple Ways to Encourage Job Creation

August 18, 2010

By Nick Schulz, DeWitt Wallace Fellow, American Enterprise Institute

David G. Blanchflower is a former member of the Bank of England’s Monetary Policy Committee. In an article in Bloomberg, he makes a powerful case for tax cuts as a way to jump start economic activity. His thinking?  Companies need incentives to hire.  Tax cuts that lower the cost of hiring employees are a good place to start. 

One idea is to slash payroll taxes, an idea advanced by my AEI colleague John Makin who says:

“If the payroll tax (of which households pay half directly) were suspended–say, for a year or eighteen months–households would experience an immediate 3.5 percent increase in disposable income that they could employ to sustain consumption and pay down debts. Since the payroll tax is regressive, falling more heavily on lower income households, its repeal would be progressive, while transferring a substantial increase in disposable income to the low-income households who are likely to need it most and therefore likely to spend most of it.

“For firms, a reduction in their payroll tax payments would reduce their incentive to lay off workers by reducing the cost of keeping workers on the payroll. In effect, firms would be prompted to shift more toward labor as a factor of production because of a reduction in the tax on employment of labor that the payroll tax entails.”

I’ll have more to say in coming weeks about the effect of taxes on economic activity. Some of my AEI colleagues are working on papers that look at the effect of taxes on American competitiveness and I’ll be reporting some of those results soon.

Meanwhile, President Obama is in the hard-hit Midwest this week talking about job creation.  A payroll tax holiday could be a bi-partisan winner.