On September 8, 2011, President Obama presented to Congress “The American Jobs Act.” The main objective of The American Jobs Act (AJA), as the name suggests, is to spur job growth and bring down the unemployment rate. The $447 billion bill includes payroll tax holidays, hiring incentives, job-retraining programs, and spending increases to achieve its goals. The unemployment rate in August 2011 stood at 9.1%, down from a peak of 10.1% in October 2009, but holding stubbornly at an elevated level after twenty-seven months of economic recovery (see Chart 1).
The main provisions of the bill can be broken down to four categories: (1) Tax cuts to increase employment and promote growth, (2) programs to help the unemployed, (3) rebuilding and modernizing programs that create jobs, and (4) tax cuts to increase consumer spending.
(1). Tax cuts to increase employment and promote growth ($70 billion)
The AJA includes payroll tax cuts for employers. Payroll tax for employers will be 3.1% vs. the current rate of 6.2%. The tax holiday is for the first $5 million in payroll, which covers 98% of businesses in the country. In addition, payroll taxes would be completely eliminated for firms that increase their payroll by adding new workers or increasing wages of existing workers (the cap is set at first $50 million in payroll increases). Putting the current trend of payroll employment in historical perspective helps to appreciate the motivation behind this provision. Chart 2 is indexed for payroll employment in all business cycles in the post-1960 period. Payroll employment is set equal to 100 at the trough of each business cycle and appropriate computations are carried out for quarters before and after the trough of each recession. A 104% reading would imply that there was a 4.0% increase in jobs, while 98% would stand for a 2.0% reduction in jobs. In the current economic recovery, payroll employment in the July-August months barely matches the level seen at the trough (2009:Q2) and the improvement in hiring ranks below each of the other post-1960 recoveries, with the exception of the 2001 experience. The payroll tax holiday is aimed at lifting the pace of hiring from this disappointing trend; the cost of this provision is $65 billion.
The proposal also allows for 100% expensing of investment, which is the largest temporary incentive in history, and the tab for this provision is $5 billion. The 2011:Q3 CFO survey conducted by the Duke/Fuqua School of Business indicates that projections of capital and technology expenditures have hit pre-recession lows (see Chart 3) and the small business survey of September points out that only 21% of respondents reported plans to increase capital expenditures in the next 3-6 months (see Chart 4). The 100% expensing option could change this gloomy outlook for capital expenditures. In the second quarter, the equipment and software spending component of GDP grew at an annual rate of 7.8%, putting the year-to-year growth at 9.7%. These are impressive readings, but the pace of growth is decelerating (see Chart 5). Businesses taking advantage of this provision of the AJA will raise the level of capital spending and contribute to economic growth.
(2). Programs to Help the Unemployed ($62 billion)
There are 7.345 million recipients of unemployment insurance under the regular state programs and special programs put in place as a result of the recession (see Chart 6) vs. a peak of 10.84 million in early-2010. There has been a reduction in the number collecting unemployment insurance but the level remains elevated after two years of economic growth.
Of those unemployed, 6.034 million (42.9% of unemployed) have not held jobs for over 27 weeks (see Chart 7). The labor market metrics of Charts 6 and 7 indicate the gravity of the problem that needs to be addressed. Long periods of unemployment render skills of workers obsolete and could lead to structural unemployment issues along with adverse socio-economic implications. The AJA seeks to improve prospects of the large number who are unemployed through several new provisions in addition to extension of unemployment insurance. At a cost of $62 billion, the bill proposes to provide a $4000 tax credit to employers hiring long-term unemployed workers and includes several modifications to the unemployment insurance program. In particular, employers have the flexibility to reduce hours of workers rather than laying them off and the lost wages are made up by unemployment insurance (UI). The bill also includes a “Bridge for Work” program under which long-term unemployed workers can continue to receive UI while they volunteer at a job on a temporary basis or pursue work-based training.
(3). Create jobs through rebuilding and modernizing programs ($140 billion)
The bill also includes programs to rehire teachers, modernize schools, setup of an infrastructure bank, a national wireless initiative and veterans hiring initiative. The cost of these programs is $140 billion
(4). Tax cuts to increase consumer spending ($175 billion)
The temporary reduction of payroll taxes to 4.2% expires at the end of 2011. The AJA also plans to cut payroll taxes of all employees to 3.1% from 6.2% for 2012. The aim is to revive consumer spending in an environment of a decelerating trend of disposable income (see Chart 8). The cost of this provision of the bill is estimated at $175 billion.
Desired Outcome is Tied to How the AJA is Financed
The key question is if $447 billion spending planned under the AJA will stimulate the economy sufficiently to create jobs and build momentum for strong self-sustained economic growth. The most recent experience of a large fiscal stimulus package, the American Reinvestment and Recovery Act of 2009 (ARRA) amounting to $787 billion, is a guide to the likely impact of AJA on job creation. According to Daniel Wilson of the San Francisco Fed, “ARRA spending created or saved about 2 million jobs in its first year and over 3 million by March 2011.” The economy lost nearly 8.8 million jobs during the recent recession and actual GDP is roughly seven percentage points below potential GDP as of the second quarter of 2011 (see Chart 9). Essentially, expansionary fiscal policy, under the provisions of ARRA, promoted growth and employment but the pace of recovery has turned out to be inadequate to a replace a large percentage of jobs lost during the Great Recession and there is still significant unused capacity in the economy.
In our opinion, the method of financing government spending is an important determinant of its success in terms of bringing about economic growth and increasing employment. Although a significant amount of government spending was put in place under the ARRA, the impact was trimmed because it was largely a transfer of spending from the private sector to government sector. It was financed by private sector savings, with the Fed and depository institutions purchasing only a small part (see Chart 10).
Once again, the U.S. Treasury will borrow $447 billion to enable the outlays listed in the AJA. The financing mechanism of these expenditures will play a big role in the nature of the outcome. The reasoning behind this point of view runs as follows: When a lender extends loans to the government, she postpones spending and the impact is a transfer of spending power from the lender (households, for example) to the borrower (the federal government). In other words, spending in the economy will not increase. But, the impact of fiscal stimulus will be different and significant if the $447 billion stimulus package is financed by “credit created out of thin air.” The Fed and the banking system are the only institutions that “create credit out of thin air.” When the Fed purchases a security in the open market, the transaction is completed by the Fed crediting the seller’s bank account the dollar amount of the transaction. The seller’s deposit increases and the banking system has more cash reserves. The banking system would then be able to extend credit by a multiple of the credit created by the Fed. This chain of events takes place under normal circumstances. Effectively, credit created out of thin air allows the recipient to purchase goods and services and thus increases total spending in the economy. The success of AJA will depend on how it is financed: an increase in spending or a mere transfer of spending power. In the interest of brevity, only a brief analysis of the importance of how government spending is financed is presented here. Readers can find an in-depth explanation and historical evidence in Paul Kasriel’s commentary of September 7, 2011.
Political negotiations will determine if all or a few provisions of the AJA will be passed. In sum, there is solid economic evidence to support considerations of the AJA. The result of this fiscal stimulus is most likely to be positive, but the magnitude will be influenced by how it is financed.