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Thursday, March 3, 2011

Unemployment: Issues in the 112th Congress

Jane G. Gravelle
Senior Specialist in Economic Policy

Thomas L. Hungerford
Specialist in Public Finance

Marc Labonte
Specialist in Macroeconomic Policy

Following the longest and deepest recession since the Great Depression, the National Bureau of Economic Research (NBER) has declared the U.S. economy to be in expansion since June 2009. The unemployment rate in December 2007 was 4.9%; by October 2009, the unemployment rate was above 10%. Although economic output began to grow in the third quarter of 2009, the labor market remained weak into 2010. For the year, unemployment averaged 9.6%, and showed no improvement in the second half of the year (although the rate fell to 9% for January 2011).

In response to high unemployment, some members of Congress proposed job creation bills, following several policy steps taken since the economy entered the recession, including stimulus bills in 2008 (P.L. 110-185) and 2009 (P.L. 111-5), an unprecedented expansion in direct assistance to the financial sector by the Federal Reserve, and the Troubled Asset Relief Program (TARP; P.L. 110-343). In December 2010, P.L. 111-312 extended the 2001 and 2003 (“Bush”) income tax cuts through 2012, extended alternative minimum tax relief and various other expiring tax provisions through 2011, extended emergency unemployment benefits, and cut the payroll tax by two percentage points until the end of 2011. Nevertheless, the Blue Chip consensus forecast has the unemployment rate remaining above 9% throughout 2011 and near 9% in 2012.

The 112
th Congress is likely to be faced with continuing questions about the need to foster job creation. Three policy issues are considered: whether to take additional measures to increase jobs, what measures might be most effective, and how job creation proposals should be financed.

Some view the measures already taken as extraordinary and expect that additional stimulus is subject to diminishing returns and unlikely to sharply hasten the expected decline in unemployment. In favor of a more interventionist approach are the costs of protracted unemployment, the possibility that a longer bout of unemployment could cause a higher permanent unemployment rate, and the possibility of a stagnant or slowly growing economy.

Most proposals discussed as part of a potential additional macroeconomic jobs bill are traditional fiscal stimulus policies. Their objective is to increase total spending in the economy (aggregate demand) either through direct government spending on programs or by providing funds to others that they will spend (through tax cuts, transfer payments, and aid to state and local governments). Fiscal stimulus is only effective when the policy options actually increase aggregate demand.

Some have proposed employment tax credits that are different from traditional fiscal policies in that their objective is to directly increase employment through a subsidy to labor costs. Studies that examined the 1977-1978 incremental jobs tax credit found mixed results—some conclude that the tax credit was responsible for creating a significant number of jobs, while others conclude that it was ineffective.

To be effective, fiscal stimulus is generally deficit financed. Although a stimulus measure could be paid for by cutting other spending or raising other taxes, these financing options will offset the stimulative effects on aggregate demand. It is possible to choose a deficit-neutral package of tax and spending changes that would stimulate aggregate demand if some types of measures induce more spending per dollar of cost than others but such an effect would likely not be very large. The choice of financing affects both the macroeconomic impact and the cost-benefit tradeoff of the policy proposal. If such an effective stimulus package could be designed, it would have the advantage of not exacerbating the challenges of a growing debt.

Date of Report: February 4, 2011
Number of Pages: 14
Order Number: R41578
Price: $29.95

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