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Wednesday, September 28, 2011

Unemployment: Issues in the 112th Congress

Jane G. Gravelle
Senior Specialist in Economic Policy

Thomas L. Hungerford
Specialist in Public Finance

Linda Levine
Specialist in Labor Economics

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, it was above 10%. Although economic output began to grow in the third quarter of 2009, the labor market remained weak into 2010, averaging 9.6% unemployment. The rate fell to 9% at the beginning of 2011 and has remained near that level.

Several policy steps were 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 other tax provisions, extended emergency unemployment benefits, and cut the payroll tax by two percentage points for one year. Nevertheless, the Blue Chip consensus forecast had the unemployment rate remaining above 9% throughout 2011 and near 9% in 2012.

Continued high unemployment has led to concerns about the need to foster job creation. Recently, the President proposed a new stimulus package that provided a 50% reduction in employee payroll taxes, business tax cuts (primarily subsidies for employment), and additional spending.

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.

Proposals for employment tax credits 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 simulative 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: September
9, 2011
Number of Pages:
Order Number: R415
Price: $29.95

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