The Economic Ignorance of Central Planners

If we want better jobs numbers, we need to deregulate labor markets

by Richard A. Epstein

One story has dominated the economic news this past weekend. The story is that job creation has slowed to a “trickle,” in the words of a Wall Street Journal headline. Only 88,000 new jobs were created in the month of March. That feeble rate was accompanied by the “good” news that the jobless rate, which only counts those actively seeking work as unemployed, had dropped from 7.7 to 7.6 percent.

The real news was that the decline in the unemployment rate was explained by the separation of nearly half a million people from the workforce, so that labor-force participation shrunk from about 67.3 percent in early 2000 to about 63.3 percent today. A crude first approximation of the real unemployment rate would add back at least 4 lost percentage points. A more accurate estimation of the actual unemployment rate would account for those individuals who were out of the market by 2000 in part because of the impediments to market performance that were already in place. 

With these weak numbers, the political discussion has continued to focus on job creation and economic growth: How should these goals be accomplished? On “All Things Considered,” I heard E.J. Dionne advise that the Federal Reserve should keep its foot on the accelerator, by opening the cash spigot and keeping interest rates at their historic lows. At the same time, the rest of the government should put worries about the deficit aside—or so the argument goes—by increasing public expenditures funded in part through higher taxes on the top one percent. David Brooks rightly disparaged that prescription, but still was unable to identify that “big structural change” he hoped would turn the economy around.

Obama’s Misshapen Tax Policy

President Obama had, of course, no doubts on what should be done. In his view, we should double down on the same policies that he has championed since coming into office. His new proposed budget modestly chips away at the cost-of-living increases in Social Security spending, which has drawn fierce resistance from his party’s incorrigible left wing.

But his preferred long-term changes all cut in the opposite direction. The President has renewed his call for capping the charitable deduction at 28 percent—a dreadful idea—even as he tries to steepen the level of progressivity of the income tax. In addition, the President unveiled a proposal to slash the amount of money that individuals can keep in their tax-deferred retirement accounts to $3 million per person. Putting aside the transitional problems that dog this proposal, the simple point is that additional taxation is likely to further retard the creation of jobs and wealth, by shrinking the size of the largest pool of private investment funds in the United States.

Handing Out Political Favors

That isn’t all. The tax system’s high progressivity drives endless political efforts by well-heeled interest groups to exempt themselves from this bold new order. Businesses that are chafing under their heavy tax burden are directing their attention to the people in Congress who pull the levers of power. High on that list is Montana’s Max Baucus (D), the longtime head of the Senate Finance Committee, which has a lot to say on both the revenue and spending side of the budget. The New York Times reports that some 28 of his former Congressional aides are now registered tax lobbyists, as are many former staffers of such influential operatives as Senators Charles Grassley (R-IA) and Charles Schumer (D-NY).

But have no fear, says Sean Neary, a spokesman for Senator Baucus. Neary assures a wary public that Mr. Baucus often “rejects” proposals from his well-connected supplicants, and that all of his decisions “are based on the merits.”

Just what merits decide which set of special benefits should be granted and which denied? Neary is never at a loss for words. “Every vote has to answer one question for him and that is: How is it impacting Montanans?” It is harder to know where the greater corruption lies: Is it in Baucus’ explicit decision to put the welfare of the tiny number of Montanans ahead of that of the other 99 percent of this nation’s citizens? Or does it lie in the delusive confidence that so benighted a senator can figure out just which of the endless special deals is worthy of his support?

Baucus has it all backwards. The essence of a sound tax policy is to make it unremunerative for tax lobbyists to skulk around Washington to obtain preserve special tax benefits for hiring veterans. But as the tax policy becomes more progressive, the more it starts to resemble Swiss cheese, which incentivizes lobbying for still other loopholes.

The next generation of special carve-outs and exceptions will be of short duration, just like the rate structure itself. The tax cliff of January 2013 was no cliff at all. It was just one of the large array of tax hills, valleys, and detours, all of which reduce or postpone investments from businesses that don’t have the foggiest idea of what the tax picture will look like once a deal surfaces. The concealed costs of the current tax uncertainty are very large. The only antidote is to flatten the rates and broaden the base, which is antithetical to the Obama mantra of “redistribution first.”

The Federal Reserve to the Rescue

Like Dionne, the President may think that stimulus from the Fed can offset his tough tax reform proposals. Forget it. We have tried stimulus programs for over four years now, and the results are anemic growth levels tied to a reduction in both the capital stock and the income levels for much of the population. David Stockman’s new book, The Great Deformation: The Corruption of Capitalism in America, may well be, as I have argued, an undisciplined rant, but the signs of illness he lists in his book and in his now notorious New York Times op-ed are all too real. Over the last dozen years, economic growth has averaged about 1.7 percent per year; business investment is about 0.8 percent per annum; family income is down about 8 percent; and the labor market has been stagnant.

More stimulus programs cannot undo the malaise. These programs introduce yet another degree of uncertainty into the overall picture. The lower rates that help businesses hurt consumers, especially retirees living on fixed incomes. No one should buy into the Keynesian delusion that the current malaise stems only from shortfalls on the demand side. No one should think that choosing between austerity and deficits will move the needle much one way or the other. Current uncertainty hurts both the demand and the supply side, thereby driving down economic productivity and increasing the deficit. The losses here really matter.

Let us assume, for example, that the Obama policies have chopped two points off growth per year, which is roughly the difference between the 1.5 percent growth we have had, and the 3.5 percent growth he promised. Compounded over the four-plus years of his presidency, the total growth decline comes out to about 11 percent—not chump change on an overall economy of about $15 trillion. No matter how one slices these numbers, stagnation always follows from massive redistribution.

Labor Market Reform

Yet, in the din of all this talk about taxation and stimulus, far less attention is paid to the administrative proposals. Redistribution and stimulus will not create jobs. So what will? To answer David Brooks, the best “big structural change” needed to create jobs is a massive liberalization of labor markets. The logic here is simple enough. Each and every form of labor regulation distorts the operation of competitive markets. For example, the minimum wage law cuts off opportunities for people to enter the labor market at the lowest rungs. Remove the regulations—including the full range of antidiscrimination laws and employer mandates, especially on matters of health care—and the labor market will start working more efficiently to create jobs and wealth.

But it may be wise for Washington politicians to take note of a recent statistic, reported in the Wall Street Journal, that the unemployment rate for people between 16 and 25 now officially stands at about 16.2 percent, a figure that rises to over 22 percent when accounting for young people who have given up or postponed the search for jobs. Historically, new entrants into the job force have always been most vulnerable in down turns. The recovery in this market segment, such as it is, has lagged behind the others. The minimum wage is the obvious, but by no means the only, culprit. Raising it across-the-board will only make matters worse for the young people in our country.

These losses are disastrous for the long-term health of a nation. The want of a first job means that young workers do not get the experience and skills that allow them to obtain a second and better job. It means that the level of transfer payments has to rise, which, in turn, imposes higher tax burdens on the economy to replace the lost income.

In the face of all this dislocation, the United States could achieve a major reduction in total government expenditures by scrapping a program that costs a small fortune to administer, while making matters worse economically. The correct social policy on this issue is to fire every worker who administers the Fair Labor Standards Act of 1938 and to supply each of them with a one-year severance package that will allow them time to secure reentry into a labor market that is sure to expand without the benefit of their destructive oversight services.

 Such labor market reforms will be blocked, of course, by the single most regressive force in American politics: the large politicized union sector, which does more harm in the political arena than it does at the bargaining table. The great shame of President Obama is that, owing to his incredible intellectual rigidity, he has not developed the economic wisdom or political courage to ditch, even in his second term, this group of supporters.

The President will administer none of this stiff medicine, of course. That is because when you ask the wrong questions, you are likely to get the wrong answers. To the President, the right question to ask is: Which form of government intervention can do most to improve the economy? The one answer that he will not accept is deregulation, which, both in the long and short run, is the only solution to the current woes.

What the President seems determined to impose on the American people is a grand economic bargain that marches us down the road to economic stagnation or worse. His policies of increased regulation will continue to stifle productive labor markets, and his redistributive programs will continue to shrink the capital base. Both of these policies will only shrink the overall size of the pie, so that the whole country will suffer. This nation deserves far better, but the prospects are glum that it will get it.