Policies for Increasing Economic Growth and Employment in the Short Term

Posted on
February 12, 2010

I was scheduled to testify a few days ago before the Joint Economic Committee about policies to increase economic growth and employment in 2010 and 2011. The hearing was canceled because of the snow, but we released my prepared remarks today. The testimony was based on CBOs January report on Policies for Increasing Economic Growth and Employment in 2010 and 2011 and on CBOs follow-up letter last week to Senator Casey, which provided additional information about options for reducing employers payroll taxes.

The testimony emphasizes three points:

First, although the economy is starting to recover from the most severe recession since the 1930s, CBO and most private forecasters expect a slow rebound in output and employment. Often, severe economic downturns sow the seeds of robust recoveries. During a slump in economic activity, consumers defer purchases, especially for housing and durable goods, and businesses postpone capital spending and try to cut inventories. Once demand in the economy picks up, spending by consumers and businesses can accelerate rapidlywhich in turn generates demand for workers. CBO expects that the current recovery will be spurred by that dynamic, but in all likelihood the recovery will also be dampened by a number of factors. Those factors include the continuing fragility of some financial markets and institutions; declining support from fiscal and monetary policy; and limited increases in households spending because of slow income growth, lost wealth, and a large number of vacant houses.

Therefore, as shown in the following figure, CBO projects that the unemployment rate will average slightly above 10 percent in the first half of this year, fall below 8 percent only in 2012, and return to its long-run sustainable level of 5 percent only in 2014. As a result, more of the pain of unemployment from this downturn lies ahead of us than behind us.

Unemployment Rate (Percent)

Second, fiscal policy actions, if properly designed, would promote economic growth and increase employment in 2010 and 2011. However, despite the potential economic benefits in the short run, such actions would add to the already large projected budget deficits. Unless offsetting actions were taken to reverse the accumulation of additional government debt, future incomes would tend to be lower than they otherwise would have been.

Third, different policies that have received public attention would have quite different effects on output and employment per dollar of lost tax revenue or additional government spending. To be sure, significant uncertainty attends any quantitative estimates of the effects of particular policies, and CBO has emphasized that uncertainty by reporting ranges of estimates. Still, significant differences can be seen in the following figure, which shows the cumulative effect of a variety of different policy options on employment in 2010 and 2011, measured in years of full-time-equivalent employment per million dollars of total budgetary cost.

The largest effects on employment this year and next would probably arise from increasing aid to the unemployed, reducing employers payroll taxes in general, and reducing employers payroll taxes for firms that increase their payroll. Somewhat smaller effects would probably be produced by reducing employees payroll taxes, providing an additional one-time Social Security payment, allowing full or partial expensing of investment costs, investing in infrastructure, providing aid to states for purposes other than infrastructure, and providing additional refundable tax credits for lower- and middle-income households in 2011. Still smaller effects would probably be generated by extending higher exemption amounts for the AMT in 2010 or reducing income taxes in 2011.

Cumulative Effects of Policy Options on Employment in 2010 and 2011,
Range of Low to High Estimates

Much of CBOs extensive analysis and writing on this topic in the past few months has been done by Janet Holtzblatt, Mark Lasky, Ben Page, and Susan Yang.