UPDATE on President Obama’s Jobs Proposal – Better, But Still Weak

First an update on a post I made a few days ago. When I commented last Monday on President Obama’s jobs proposal, I was less than excited. Having read more detail of the proposal, I should correct some statements I made.  I incorrectly left the impression that the payroll tax (Social Security/Medicare tax) cut that the President was proposing was only an extension of the present year cut that is scheduled to expire December 31, 2011.

In fact, the President is proposing not only a 1 year extension of this year’s temporary payroll tax cut, but an increase in the size of that tax cut.  Estimates are that for a median household income of near $50,000, it would result in a $1,500 reduction in payroll taxes compared to not having any payroll tax cut at all. However, the existing, this-year only, payroll tax cut had already cut payroll taxes by up to $500 per household.  So of the claimed $1,500 tax cut for next year for the median household, $500 is an extension of this year’s situation and  $1000 is new stimulus.  Today’s economy is weak even with the existing temporary $500 tax cut, so extending that cut won’t improve things. It will only prevent things from deteriorating further.  In my world, simply agreeing to not put on the brakes is not the same thing as actually hitting the accelerator.

But, the proposal does contain perhaps $1000 worth of tax cut stimulus to nearly all working households. That’s perhaps $150 billion of pure, new stimulus to economy.  It’s more than I estimated on Monday, so the plan will likely have some more stimulative effects than I thought.  But how much?  Let’s do a quick “back of the envelope” type calculation.  The proposal puts $150 billion in consumers’ hands that wouldn’t have been there without it.  But for this money to generate jobs, people have to spend the money.  Simply saving the money or paying down debt won’t cut it.  That improves individual household balance sheets but it doesn’t cause any firm out there to go “oh, more business! I need to hire people!”  In normal times like the 1960’s or 1970’s people would have spent 85-90% of the tax cut.  But these aren’t normal times. We live in high debt, high debt payments, and scared-of-the-future times.  More people save in these kind of times. (paying down debt is economically the same as savings – think of your debt as a negative balance in a savings account).  Let’s assume that people spend 2/3 of the money.  Both history and theory indicate that people save more of a tax cut when they know it’s temporary, but let’s be generous/optimistic and say 2/3 gets spent.  That’s $100 billion in new spending.

Now when it gets spent, it generates business demand and jobs.  Those people get paid and then they go spend the money again – the circular flow of money in the economy.  How much?  That’s a huge controversy in empirical macroeconomics.  This is the question of what the spending multiplier is.  Estimates vary widely, although often the studies are heavily biased by ideology to begin with.  Let’s be modestly optimistic and say the multiplier is 1.5 – 2.0.  This is a relatively high estimate given recent studies as far as I know, but let’s run with it.  That means that after some months, this initial $150 billion in tax cuts becomes $100 billion in new, initial spending which ultimately increases total spending by $150-$200 billion.  Total spending is another way of saying GDP.  This puts it in the range of 1.0% to 1.5% of GDP.

There’s a rule of thumb about the relationship between changes in GDP to changes in unemployment rate. It’s called Okun’s Law.  It’s not a law so much as a statistical regularity. There are many versions, but let’s use a real simple one: each 2 percentage point change in GDP equates to a 1 percentage point change in the unemployment rate.  So if we have GDP growth increasing by 1.5% points, we can count on unemployment rate going down by 0.75 to 1.0% points.

We’re currently over 9% unemployment rate and stuck there.  I’m not real excited about a proposal that aims to reduce the unemployment rate from over 9% to maybe 8%.  We know 4-5% unemployment is possible.  We did it in 2006 even with the slow-growth policies of the Bush administration.  We did better than that under Clinton. In the 1960’s we were even below 4%.   Why are we settling for tepid responses and setting goals of only getting to 8% unemployment and then calling this “bold”?  I don’t know.  But then maybe I’m just a grumpy old man.

5 thoughts on “UPDATE on President Obama’s Jobs Proposal – Better, But Still Weak

  1. A mistake made by everyone, Republican and Democrat alike, is calling the payroll tax a “tax” as if it is just like any other tax we pay. It isn’t.

    The part of the payroll tax you are talking about in this article is more akin to an investment in a personal retirement plan, like a 401(k), that we pay into rather than a traditional “tax” to pay for government goods and services like roads, defense, police, teachers and politician salaries.

    Now the President proposes to take 1/2 of all the money we put into our own retirement plan, including the matching funds from our employers, and give it back to us and them to spend for just one year – 2012.

    That works out nice for politicians seeking re-election in 2012… more money in voters pockets for the duration of the election magnanimously given to them in the name of economic recovery translates into more votes for them in 2012. Never mind that the extra $1,500 in their pockets disappears in a heartbeat a couple months after the election.

    Is there any economist in the United States that really thinks this temporary 1-year $1,500 boost will do much to create lasting, sustainable jobs that will permanently turn the economy around? Or is this another ineffective expenditure of a massive amount of money like we made with ARRA that we will have to pay back that only helps a little bit right up until the money runs out?

    One politician has been thoroughly trashed by the national press for calling Social Security a “ponzi scheme” – nothing more than mere words.

    Yet this payroll tax reduction proposal ACTIVELY weakens Social Security in a very, very real way. Years ago Social Security degenerated into a PAYGO system. Every penny in the Social Security “Trust” fund has long since been borrowed and spent. Nowadays, reduce the amount of revenues taken in and the difference is directly added into our enormous national debt. In 2010, the year before the first payroll tax reduction, Social Security fell about $38 billion short of its expenditures for the first time in history. With this years 2011 payroll tax reduction it will be over $100 billion short and next year, with this new proposal, it will be well over $300 billion short in 2012.

    Yet nary a peep about the harmful effects of the payroll tax reduction to the Social Security system itself is mentioned in this article. Why?

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  4. azleader,

    What you sound like you want is a “lock box” to put Social Security into. No one can touch that “lock box” and we should hide it under the bed. What is your problem with national debt? The only way I see national debt as a problem is if the United States closes up shop and has to pay everyone back. That’s not going to happen any time soon. People still want to buy US Debt instruments despite their value being that of MAYBE inflation. That’s a 0% real interest rate, that’s not a very good investment. Yet people are still buying. It’s a conundrum, but I’m willing to bet that the people who think national debt is a huge problem believe that our currency is backed by gold. Its not. And with unemployment the way it is, I say we inject some more cash into the hands of those that want to spend it. And I’m a Top 1% Playa…

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