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Stimulating jobs in a climate of political gridlock

Dismal. Glum. Miserable. Terrible. These are among the words journalists have used to describe the finding of statisticians at the Bureau of Labor Statistics: The American economy on net did not add a job in August.

What will it take to restore the recovery and convince employers to hire again? What can be realistically expected out of Washington considering political gridlock? The President will address a joint session of Congress about the parlous state of the job market and economy on Thursday, Sept. 8. Republican rivals are hammering the President over the job numbers and coming up with their own solutions. "The political summer has ended, and now, with nothing resolved in the interim, the fight is moving back inside the Beltway," write Jonathan Allen and Jake Sherman on the Politico website. "Call it the fall brawl."

Just what the unemployed need.

There's a better ways, says Robert Frank. He's an economics professor at Cornell University's Johnson School of Management, an economics columnist for the New York Times, and a Distinguished Senior Fellow at Demos. His post draws on his recently published book, The Darwin Economy.

Frank argues for a practical way to both boost the economy and navigate Washington politics. His post is longer than usual, but the stakes are higher than normal.

Robert Frank: Experienced policy economists from both parties are in broad agreement that additional government stimulus would not only help put the economy back on track, but would also result in much smaller budget deficits in the long run. Yet most observers also regard that step as "politically unthinkable."

In an apparent nod to Voltaire's admonition that the best is the enemy of the good, the Obama administration has shifted course. Eschewing proposals for large-scale grants to state and local governments or direct spending on infrastructure--the most effective forms of stimulus--the White House now favors a mix of business and personal tax cuts.

Evidence suggests that the longstanding Republican opposition to taxes of all sorts makes them less likely to oppose this approach than one calling for direct spending increases. In December of 2010, for example, the Republican majority in the House joined the Senate in approving the president's proposal to reduce the employee portion of the payroll tax from 6.2 percent to 4.2 percent of annual salaries up to $106,400. That reduction is currently set to expire at the end of this year, but the president has recently proposed extending it.

If tax reduction is the only politically feasible form of stimulus, Congress needs to consider a much more aggressive reduction of the payroll tax. That tax, after all, constitutes the biggest tax burden currently faced by low-income workers, who typically owe little in federal income taxes.

With the economy still struggling, the case for suspending this tax altogether is compelling. For a worker earning $1000 a week, a temporary full payroll tax holiday would translate into an immediate gain of $62 a week in take-home pay, much of which would be quickly spent. The University of Delaware economist Larry Seidman has estimated that suspending the employee's share of the payroll tax would cause the national unemployment rate to decline by a full percentage point by the end of 2012 relative to what it would have been otherwise.

Employers also face a 6.2 percent payroll levy on each employee's annual salary up to $106,400. Congress should leave that levy in place for existing workers but declare a full holiday from the employer levy on all new hires until the economy recovers from the current downturn.

Unlike many other business tax cut proposals, this two-part payroll tax holiday would immediately strengthen firms' incentives to hire additional workers. The standard hiring criterion, found in every economics textbook, is that a firm will hire if and only if revenue from the sale of what new employees produce is at least as great as the cost of hiring them. The payroll tax holiday I propose would immediately affect both sides of that cost-benefit comparison. On the cost side, a newly hired worker whose pre-tax wage is $500 would cost $31 a week less to hire than before. And because all workers in the country would have more post-tax income to spend, demand for goods and services would increase, making it easier for employers to sell the new workers' output.

The proposed payroll tax holiday would thus have a very different impact on hiring incentives than a reduction in the income tax rates paid by business owners. Advocates of extending the Bush tax cuts on the wealthy defended their position by saying that doing so would spur additional small business hiring. But that assertion completely defies economic logic, which makes clear that hiring decisions simply do not depend on business owners' after-tax incomes. The only relevant question is whether new workers will boost revenue by more than they cost. If so, hiring them would make sense, even if the owner were poor. But if not, hiring wouldn't make sense, even if the owner were a billionaire.

Depending on the duration of the payroll tax holiday, it could reduce federal tax revenue by several hundred billion dollars or more. But when the economy is mired in a deep and persistent economic downturn, short-run deficits are essentially irrelevant. With incentives keeping consumer and investment spending well below normal for the time being, the imperative is to increase total spending by enough to put everyone back to work as quickly as possible. Accomplishing that goal would actually be the most productive possible step toward achieving long-run deficit reduction.

Enacting a payroll tax holiday shouldn't end discussion of more forceful and effective proposals to stimulate employment, such as steps to refurbish the nation's failing infrastructure.

Americans rich and poor have been driving on crumbling roads and over unsafe bridges for decades. Many now live in the shadow of dams that could collapse at any moment. Water and sewage systems fail with alarming frequency. Chronically deferred maintenance has left countless schools in shambles. These problems demand immediate attention, quite apart from the fact that attending to them would put people back to work.

We must keep posing hard questions to deficit hawks who argue that spending money in these ways would impoverish our grandchildren. Timely infrastructure maintenance would have no such effect. On the contrary, it would enrich our grandchildren. And it would speed an end to the current downturn.

But if enacting a payroll tax holiday is the most that can be achieved politically, it would certainly be better than doing nothing.

About the author

Chris Farrell is the economics editor of Marketplace Money.

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