President Obama’s so-called “American Jobs Act” consists of $447 billion in tax cuts and spending increases meant to stimulate job creation and economic growth.
More than half of the proposal, at $240 billion, is allocated towards cutting the payroll tax. The employee side of the payroll tax is cut by 3.1% for a total cost of $175 billion; while the employer side of the payroll tax is cut by 3.1% for the first $5 million of payroll and by 6.2% for new hires and pay raises for current employees, all at a cost of $70 billion.
The next largest provision of President Obama’s proposal is spending $140 billion on public work projects and state aid. This consists of $50 billion to be spent on highway infrastructure and public transportation, $35 billion to subsidize teacher and first responder employment by state and local governments, $30 billion to state and local governments in order to “modernize” schools, $15 billion towards repurposing vacant property (basically, an urban renewal program), and $10 billion towards an “Infrastructure Bank” which would leverage private funds for public work programs.
In addition to all of the above, President Obama’s proposal allocated $49 billion toward extending unemployment benefits, while the rest of the money in the proposal is allocated toward programs such as the “jobs tax credit” for the long-term unemployed.
The payroll tax cuts for employers will reduce the cost to employers of hiring labor. This reduction in cost of hiring labor can, in turn, be expected to increase demand for labor, thereby encouraging employers to hire new workers or increase pay to current employees.
Also, by cutting the employer’s share of payroll taxes, employers will have more money to invest into growing their business. Of course, increased investment would boost aggregate demand, thereby boosting short-term economic growth. More importantly, however, is that increased investment would boost economic growth in the long run, thereby providing us with higher living standards years down the road.
The payroll tax cuts for employees will put more money in the pockets of the average person, thereby encouraging them to spend their money on consumption goods or to save/invest their money. Either of these options will boost aggregate demand, thereby increasing economic growth. Households could use the tax cut to pay down debt, which might not stimulate economic growth immediately, but by deleveraging and cleaning up household balance sheets, this could encourage economic growth in the long-run. Thus, the payroll tax cut for employees will ease any hardships that working families might be facing while stimulating economic growth.
However, there are several problems with the President’s proposal.
First of all, extending unemployment benefits is contrary to the President’s stated goal of stimulating job creation and economic growth. Extending unemployment benefits simply encourages the unemployed to remain unemployed – why work when you’re being paid not to?
Secondly, the federal government is in a precarious situation when it comes to its debt-to-GDP ratio, which is now pushing 100%, so it would not be a wise idea to pass this stimulus bill without some concrete proposals about how to reduce national debt in future years. The President is proposing to pay for the “American Jobs Act” at least partially by raising taxes. Though this is one way to pay for the jobs bill, it may not be the best way - a study coauthored by Christina Romer, who was the former head of the Council of Economic Advisors under President Obama, shows that increasing taxes by 1% of GDP for deficit reduction purposes leads to a 3% reduction in GDP. So the President’s proposal goes about paying for his stimulus bill the wrong way.
Thirdly and lastly, while paying state and local governments to keep teachers and first responders employed might make sense from an aggregate demand point of view, it is important to note that in effect it bails out state and local governments which spent profligately during good economic times. It would be better to allow those governments to suffer the consequences of their fiscal irresponsibility, in order to encourage fiscal prudence in future years.
Overall, I think that the President’s job plan does more harm than good due to the fact that a significant portion of the plan is allocated towards extending unemployment benefits and implicitly bailing out state and local governments.
Leaving the unemployment benefits and government-bailouts aside, there are better ways to utilize the approximately $450 billion in the jobs bill. Given the stated goal of stimulating job creation and economic growth, it would make sense to focus most if not all of the bill toward cutting the employer’s share of payroll taxes. This would immediately increase the demand for labor, thereby alleviating unemployment directly. This, in turn, would boost consumer demand, thereby further boosting the economy in the short-run. Moreover, as noted before, cutting the employer’s share of payroll taxes would leave more money in the hands of employers, thereby encouraging investment, which would boost long-term economic growth.
Furthermore, there are better ways of paying for this bill and reducing the deficit than raising taxes, as President Obama has proposed. The single best way to go about reducing the deficit would be to reduce transfer payments, which have no net impact on aggregate demand, such as Social Security and unemployment benefits. We could go about doing this by means-testing these programs and gradually reforming them to include personal accounts or, better yet, phasing these programs out over the long term.
"Obama's Job Speech: A Call to Action." The Economist. 9 Sept. 2011. Web. 25 Sept. 2011.
Romer, Christina, and David Romer. "The Macroeconomic Effects of Tax Changes: Estimates Based on a New Measure of Fiscal Shocks." American Economic Review (2010). Web.