First of all, my apologies for the bluntness of the title. As regular M&A readers know, I tend to be a tad more subtle in my characterization of things–only this time I had a hard time finding a better substitute for “dumb” other than “stupid”.
So, where to begin?
Let me start with a simple statistic: Real personal consumption expenditure (PCE). Since this past September, real personal consumption has exceeded the pre-crisis peak it reached in December 2007. In other words, Americans on aggregate are buying as much stuff (in volume terms) as before the official onset of the recession.
Now, this is not necessarily something to celebrate: On an annualized basis, real personal consumption has only grown 0.1% since December 2007, compared to the 3.5% during the decade leading up to the crisis. But there is still something impressive going on: Real consumption is back to its 2007 levels despite the fact that the number of people employed (in non-agricultural sectors) is some seven million less than it was back in end-2007.
In fact, (the admittedly crude measure of) real PCE per employed person has grown 1.9% annualized throughout this crisis, which is pretty close to the 2.1% we saw over the previous decade, especially considering the kind of crisis to that we’ve had to the economy and to consumer confidence.
What’s my point here? That the problem with the economy is not that (employed) Americans don’t consume enough; it is that we have too many unemployed people who can’t consume, not even the basics. And this is my first reason why giving a tax gift to employed Americans is a completely dumb policy: Not only is it unfair to the unemployed; it is questionable whether those Americans with jobs and with comfortable cash positions are going to spend this tax gift, if they are already close to reaching their long-term consumption growth. So much for a “targeted”, “efficient” fiscal “stimulus”.
Second. Let’s imagine for the moment that the American government was in a fiscally strong position, sustainable deficits and all, and hence with lots of extra cash to spend to boost the ailing labor market. Is a cut on payroll taxes really the best idea they’ve got?
No. Think of labor supply and demand. Right now, at the going wage, the supply of labor exceeds by far demand for labor (for which reason we have high unemployment).
What does the cut in the payroll tax do? If anything, it reduces labor supply. This is because employed workers could work fewer hours and still end up with the same amount of disposable dollars as before the tax cut. So, at the margin, they would reduce the hours they offer to work. (To throw a bit of jargon, the labor supply curve shifts to the left: i.e. less labor is offered for a given wage).
Now, this might (temporarily) close part of the labor supply-demand gap—i.e. reduce unemployment. But that’s a reduction for the wrong reason! What we really need is for unemployment to get reduced due to an increase in labor demand (ie policies to shift the labor demand curve to the right!). So, in theory, *if* the government had cash to spare, and *if* companies’ reluctance to hire were driven by a liquidity constraint, the appropriate policy response to raise employment (and thus, consumption, GDP growth and so on) would be to give a temporary cut in the employers’ portion of the payroll tax, not the employees’. However, neither of these two “if’s” holds: Neither is the government in good shape, fiscally; nor is companies’ hesitation to hire the result of a liquidity constraint—at least on aggregate. As the Fed’s flow of funds data show, since end-2009, non-farm non-financial corporates’ liquidity position (proxied, very roughly, by the ratio of cash-like financial assets over credit-market liabilities) has returned to its pre-crisis level. Meanwhile, corporates are already getting a huge “stimulus” from the very low interest rates, which are reducing significantly the costs of servicing their debt. So no, companies don’t need a payroll-tax gift to raise labor demand.
Then… I mentioned interest rates. In case you missed it, the 10-year Treasury yield moved up 32 basis points (0.32%) last week, which has already caused quite a bit of bleeding in the financial community. But bankers aside, the key question here is… whither long-term borrowing rates for corporates and households? And to what extent might the Administration’s tax “compromise” undermine the recovery by raising financing costs due to perceptions of fiscal profligacy?
Let’s see. Clearly, the rise in 10-year yields was not just due to fiscal concerns. According to a survey (of traders and buy-side participants) that I saw, a bit more than a third of those surveyed thought it was due to a higher growth outlook and between a quarter and a third thought it was because of the fiscal implications.
It is my personal view that the market is overestimating the growth impact of the “stimulus.” As I explained above, the economy has heterogeneous agents: But those who are unemployed, over-indebted and cash-constrained (and who would be more likely to spend any extra cash) are getting very little help; while those with jobs and comfortable cash positions are getting most of the help. In this sense, a downward revision in the market’s perception of the growth impact might actually lower long-term borrowing rates.
On the other hand, the fiscal risks are underestimated in my view, which doesn’t bode well for borrowing costs going forward. It’s not that I have in my possession the perfect fiscal-sustainability model of the US economy. It’s because it is now clear that the American government (and I include both parties under “government”) has once again shown to be incapable of introducing targeted measures that tackle the root of the problem and that have the biggest bang for the taxpayer’s buck.
Such policies would include measures (e.g. cash transfers) to facilitate the deleveraging of underwater households; measures to support the retraining of the unemployed, and thus avoid skills-erosion due to prolonged unemployment; and a bipartisan commitment to a more predictable regulatory environment and a sustainable fiscal outlook, so that businesses can plan for the long-term, including in their hiring.
In this context, describing the measures proposed last week as a “compromise” would be laughable, if one actually had the luxury to laugh with the US fiscal outlook. But in the current situation, they are dumb at best, if not potentially damaging.
Originally published at Models & Agents and reproduced here with permission.
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