The Fed understands the Romer/Sumner tax cut argument (too bad Congress is brain dead.)

Christina Romer and I have both advocated employer-side payroll tax cuts.  When nominal wages are sticky, that shifts the SRAS to the right, and boosts output if the Fed is targeting inflation.  On the other hand employee-side cuts boost AD, and may be ineffective if the Fed targets inflation.  What does the Fed itself think?

The central bank “is performing about as well as it can on both mandates” of price stability and full employment, Kocherlakota said. It needs help from non-monetary policies such as hiring subsidies to offset the uncertainty and adverse credit conditions that are keeping companies from adding jobs, he said.

But hiring subsidies will only work to boost jobs if the Fed eases monetary policy further, he told reporters later.

Asked if he will support more policy accommodation if lawmakers pass hiring subsidies, Kocherlakota said that such a response would be “appropriate” if subsidies put downward pressure on inflation, as he predicts they would.

Interestingly, his view that hiring subsidies are a key policy tool for boosting employment squares with a paper released Monday from the San Francisco Fed, whose chief is among the most dovish at the U.S. central bank.

The Fed gets it; both the doves and hawks understand the AS/AD model.  Too bad our Congress doesn’t understand, and keeps passing ineffective employee-side payroll tax cuts.


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25 Responses to “The Fed understands the Romer/Sumner tax cut argument (too bad Congress is brain dead.)”

  1. Gravatar of D R D R
    26. March 2012 at 06:44

    Core PCE is still under 2 percent, and though unemployment is falling it is almost exclusively due to labor force dropouts.

    Besides, doesn’t this rest on the assumption that businesses are not hiring because profits (7.3 percent of GDP in 2011Q3) are still too low?

    And since when do we think that wages are upward-sticky?

  2. Gravatar of Morgan Warstler Morgan Warstler
    26. March 2012 at 07:12

    Liberals make the same mistake when they hear Ben support Federal Spending

  3. Gravatar of John Thacker John Thacker
    26. March 2012 at 07:55

    How much is it “our Congress doesn’t understand,” and how much of it is “[our Congress is afraid] our voters don’t understand?” How much do people understand tax incidence?

    And even if voters understand, consider that even in a bad economy, most voters are employed, so they might favor employee-side cuts that seem to benefit themselves directly to employer-side cuts that are aimed at helping the unemployed get hired. (From the first level of analysis.)

  4. Gravatar of Becky Hargrove Becky Hargrove
    26. March 2012 at 07:56

    I am a bit confused about the context for hiring subsidies: public or private, or was this a part of the discussion?

  5. Gravatar of Cthorm Cthorm
    26. March 2012 at 08:15

    Congress and the President are choosing the option that is clearly superior in the framework they understand, PR. In the anti-capitalist anti-Wall St narrative politicians would look like they’re giving a handout to companies if they reduced the employer-side payroll tax and not the employee-side. From their perspective they’d rather shift the whole burden from employees to employers…which shows how stupid that framework is. But this also shows how unrealistic the tax cut idea is. The best you could hope for is an equal cut to each side, but even that didn’t fly. The Fed can’t act as if monetary policy is a collaborative enterprise with Congress, it needs to do it’s job with or without the help of Congress.

  6. Gravatar of W. Peden W. Peden
    26. March 2012 at 08:56

    John Thacker,

    I’d add “How much can the policy be spun by special interest groups?”

    I doubt that Americans would oppose the policy that we should “Cut taxes on employing people so as to reduce unemployment”. However, there are a lot of groups competing for the resources involved in such a tax cut, and they are sufficiently articulate & interested to spin it as “Trickle-down economics through tax cuts for big busienss Wall Street greed.”

    Most good policies are politically viable, except for the fact that some important people (not necessarily many people) can benefit from bad policies.

  7. Gravatar of W. Peden W. Peden
    26. March 2012 at 08:57

    * My rhetoric was out of date: “”Trickle-down economics through tax cuts for big busienss Wall Street greed- a tax cut for the 1%, not the 99%.”

  8. Gravatar of W. Peden W. Peden
    26. March 2012 at 08:57

    (And my spelling sucked: “busienss” is what most people call “business”.)

  9. Gravatar of Bill Ellis Bill Ellis
    26. March 2012 at 09:48

    @ W Penden.

    I am confident we could find enthusiastic support from the ‘99%” for Employee-side tax cuts if they were limited to “Small Businesses”.
    Obama, who’s OMB has declared that, “Small businesses are the engine of job growth in our economy…” should not have a problem selling them either.

    (How effective Employee-side cuts would be if limited to “small businesses” I have no Idea myself.)

    Would the ‘1%” allow themselves to be cut out of the deal ? I doubt it.

  10. Gravatar of DonG DonG
    26. March 2012 at 10:14

    my feeling is that a temporary employer side cut will not produce much in employment, because employers know it is temporary. Since the cut is a transfer from future taxpayers (income, not FICA, mostly individuals), I don’t like a stimulus which is a net transfer from employees to employers.

  11. Gravatar of Benjamin Cole Benjamin Cole
    26. March 2012 at 10:46

    Jeez, the GOP and the Dems would shoot the economy in the nuts if they thought the shot would ricochet and hurt the other party.

    More smart blogging from Scott Sumner.

  12. Gravatar of Major_Freedom Major_Freedom
    26. March 2012 at 10:46

    DonG:

    my feeling is that a temporary employer side cut will not produce much in employment, because employers know it is temporary. Since the cut is a transfer from future taxpayers (income, not FICA, mostly individuals), I don’t like a stimulus which is a net transfer from employees to employers.

    Future taxpayers include employers. Money is fungible.

  13. Gravatar of Ron Ronson Ron Ronson
    26. March 2012 at 11:37

    “But hiring subsidies will only work to boost jobs if the Fed eases monetary policy further”

    If the fed paid for this subsidy by new money creation and committed to keep on increasing the subsidy until NGDP forecasts were at the appropriate level , wouldn’t that solve the whole problem ?

  14. Gravatar of W. Peden W. Peden
    26. March 2012 at 11:50

    Bill Ellis,

    I wouldn’t even use the 99/1 percent language in the first place (99% of what? Income? Wealth? And at what period in their lives? etc.).

    I agree that small businesses get hurt by employer-side taxes. This is true whether or not they are formally called taxes e.g. the minimum wage is (if it works as advertised) equivalent to a redistributive tax from employers, including small businesses, to workers. As with regulations, there is the strong possibility of a disproportionate amount of pain being put on smaller businesses since tax evasion is subject to economies of scale.

    I tend to think that the solution to these regulatory and tax problems is not to introduce special measures for small businesses (which just opens up the door to MORE rent-seeking and general market distortions) but to reduce or eliminate the source problems. In the case of employer-side payroll taxes, it’s not clear to me why we need a regressive tax on employment in the first place. Taxing positive externalities (employing people) is a really weird thing to do from a non-political standpoint, even if one accepts the mythology that social insurance is some sort of real (i.e. acturial and personal account-based) insurance scheme.

  15. Gravatar of Lord Lord
    26. March 2012 at 12:10

    Too bad this post is brain dead. If you assume a supply shock, then yes, lowering production costs helps. If you assume a demand shock, then no, for there is no demand for increased supply. Sticky prices thwart lowering prices and increased demand does not increase prices under a demand shock. Inflation has been stable not accelerating and corporate profits are at historic highs. If there is a lack of hiring while profits are high, why would this change if they were even higher? The irony with this post is it is always argued it makes no difference whether paid by employee or employer since employers consider total cost and they could as well defer raises.

  16. Gravatar of Lord Lord
    26. March 2012 at 12:23

    Even more ludicrous is wage costs for new hires are held up by not offering employer subsidies.

  17. Gravatar of Lorenzo from Oz Lorenzo from Oz
    26. March 2012 at 12:36

    Lord: If you assume a demand shock, then no, for there is no demand for increased supply. I took it that the post assumed an upward sloping SRAS curve, so if you shift the curve downwards, even without any change in the demand curve, there would be increased output.

    Sticky prices thwart lowering prices and increased demand does not increase prices under a demand shock. Is not the second clause of this self-contradictory? Does not a negative demand shock rather preclude increased demand? Also, not all prices are presumed to be sticky. Certainly, Australian experience is that supply-side reforms can increase output, even with highly “sticky” wages.

  18. Gravatar of Tommy Dorsett Tommy Dorsett
    26. March 2012 at 12:49

    Scott — Did you see this?

    http://seekingalpha.com/article/456681-the-basic-arithmetic-of-self-financing-fiscal-policy

    Delong/Summer’s argue for a Keynesian fiscal stimulus free lunch.

  19. Gravatar of TylerG TylerG
    26. March 2012 at 17:11

    Scott,

    I know you’ve already been beating a dead horse over the profession’s tendency to downplay the significance of monetary policy, but just in case you want some more ammo:

    http://news.yahoo.com/fed-not-pump-more-money-economy-2012-survey-200634680.html

    “However, 81 percent of economists surveyed said the Fed should not pursue another round of quantitative easing or bond-buying this year.”

  20. Gravatar of StatsGuy StatsGuy
    26. March 2012 at 18:02

    You assume the Fed is targeting perfectly, and not within a band, or asymmetrically. You’ve even said this in the past – you should let folks know this. The magnitude of the subsidy is small, and unlikely to have much effect even at the margin. If the Fed really wants higher inflation but is unwilling to employ QE type tools to get it, the question is whether congress’ policies are goosing demand or not.

    You’ve written this post several times, and every time you make strong assumptions about the Fed precisely targeting inflation. What if the Fed WANTS Congress to goose demand, and is in effect saying “don’t worry, in the future when rates do rise above the zero bound we’ll keep them lower longer to cover the cost to the fiscal sheet”?

    Actually, isn’t that EXACTLY what Bernanke has done in promising not to raise rates till 2014?

    Sooo…. what’s the difference between fiscal and monetary policy again, other than WHERE the money gets injected (or is threatened to be injected) into the economy?

  21. Gravatar of ssumner ssumner
    26. March 2012 at 18:37

    DR, You said;

    “Besides, doesn’t this rest on the assumption that businesses are not hiring because profits (7.3 percent of GDP in 2011Q3) are still too low?

    And since when do we think that wages are upward-sticky?”

    This post has nothing to do with wages being sticky upward, but since you asked, yes they are. Rather the key assumption here is that they are sticky downwards. A payroll tax cut won’t cause wages to rise, because they are currently above equilibrium (due to the earlier stickiness downward.)

    Profits are high but companies are insatiable–they always want even higher profits. When you cut the employer-side payroll tax the profit-maximizing employment level rises. It’s a supply-side argument that has nothing to do with what companies can “afford.”

    John Thacker, It’s both.

    Becky, Public subsidies to private firms.

    Cthorm, Agreed.

    DonG, If it had been done for several years it would have helped. If we could go back in time I’d do it in 2008, and do no other fiscal stimulus.

    Thanks Ben.

    Ron, It might, but they don’t need to directly pay for it, they need to do what’s necessary to keep inflation from falling.

    Lord, You said;

    “Too bad this post is brain dead.”

    It’s obvious from the rest of your comment that this stuff is way over your head. The argument that it doesn’t matter whether taxes are put on employees or employers is so off topic that I wonder why you even bother to read this blog.

    Tommy, Yes, I have a new post on that.

    TylerG, That’s exactly the problem. Even worse, I’ll bet that LESS THAN 81% OPPOSE MORE FISCAL STIMULUS. The profession has become an embarrassment.

    Statsguy, No, I am not making any of the assumptions you claim. Suppose they don’t target 2% inflation, but rather promise to keep inflation in a 1% to 2% range, with 1.5% being the average inflation rate. The exact same argument applies. I haven’t made any unrealistic arguments at all.

    You said;

    Sooo…. what’s the difference between fiscal and monetary policy again, other than WHERE the money gets injected (or is threatened to be injected) into the economy?”

    They are completely different. Monetary policy boosts NGDP and inflation, this sort of fiscal stimulus reduces inflation (unless offset by the Fed.)

  22. Gravatar of D R D R
    27. March 2012 at 11:10

    “Profits are high but companies are insatiable-they always want even higher profits. When you cut the employer-side payroll tax the profit-maximizing employment level rises. It’s a supply-side argument that has nothing to do with what companies can ‘afford.'”

    There you go again. I never used the word “afford.”

    I’m just trying to understand your argument. If you think that employment is determined by real compensation, then employment is too low because real compensation is too high. But you always deny this.

  23. Gravatar of ssumner ssumner
    28. March 2012 at 10:26

    DR, You said;

    “Besides, doesn’t this rest on the assumption that businesses are not hiring because profits (7.3 percent of GDP in 2011Q3) are still too low?”

    and then you said:

    “There you go again. I never used the word “afford.””

    Now I have no idea what the previous quotation meant. Why did you think the high levels of profit were relevant to this discussion?

    The problem is that the ratio of labor costs to NGDP is too high for full employment. The solution is more NGDP. But if we can’t have more NGDP, then at least the government can reduce labor costs.

  24. Gravatar of D R D R
    28. March 2012 at 11:17

    Scott,

    My current understanding of your argument is as follows:

    You’re saying businesses should get a tax cut precisely because they won’t pass it along in higher wages. You’re saying they’ll see higher profits than what they are seeing now, and this will induce them to expand output.

    I’m suggesting that if the record profits we see today are not sufficient to induce an expansion of output then maybe increasing those profits will do no more than that. That they don’t necessarily profit by expanding output unless they find a way to sell that output. That “cost of labor” is still last in NFIB’s survey.

  25. Gravatar of ssumner ssumner
    2. April 2012 at 18:36

    DR, No, I’m not saying the higher profits will induce them to raise output, I’m saying the profit maximizing output level will rise when the MC curve shifts downward. That’s the prediction of both perfect competition and monopoly models.

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