What's the Best Way to Lower the Unemployment Rate?

Photo: Indigent men wait in a breadline in New York in 1910.

Where are the jobs? It was a refrain for Republicans during the midterm elections as they derided Democrats for their inability to drive down perilously high unemployment rates. But it increasingly appears that neither party has a proven formula for how to stimulate job creation in the short run. That doesn't mean there's a lack of ideas. But there's little consensus on which ones would work best, how quickly they would work, or how many jobs they might create. The problem is that while everyone agrees on the goal--stimulating economic growth--there's little agreement on how to get there. "People often ask me why economists disagree," says John Taylor, a conservative professor of economics at Stanford. "I don't question their good faith. It's usually a question of magnitude." For example, liberals believe the cost of health care is so large as to stifle economic growth. Conservatives argue that health-care reforms passed last year have a larger negative impact on the economy. How you feel about future policy will depend on which of those two effects you believe is larger. Since there's little appetite on either side of the aisle for direct employment programs that echo the Depression-era Works Progress Administration or Civilian Conservation Corps, the question is how best to stimulate economic growth that will bring employment with it. But it turns out that the economy has actually been growing since June 2009, according to the official arbiter, the National Bureau of Economic Research. And still the unemployment numbers are stuck at 9.6 percent. "We've gotten fewer jobs than we would have anticipated given the growth," says Bruce Bartlett, who was an economic adviser in the Reagan and the first Bush administrations. So now what do we do? Here are the most popular proposals, how they work, and who's calling for them.

Theory: Although most fiscal policy, the revenue collection and spending controlled by Congress, is gridlocked, lawmakers are scrambling to take action on soon-to-expire temporary tax breaks passed during the George W. Bush administration. Almost everyone agrees that returning tax rates to their former, higher level, which would happen Jan. 1, could have an antistimulative effect. But liberals argue that a 4.6 percent increase for the small number of Americans in the top tax bracket wouldn't have a catastrophic effect, and would help to narrow the budget deficit. Conservatives counter that the increase would hit small businesses hard. While it might not affect a huge number of them, it would affect the ones that employ the most people--the largest of the small, in other words. The Congressional Budget Office, a nonpartisan agency that assesses the impact of legislation on the national budget and economic policy, found in a January 2010 report (PDF; see page 18) that keeping income taxes at their current rates through 2011 would have a negligible stimulative effect in the short run.

Proponents: Republicans favor extending the cuts for all Americans, while Democrats prefer to extend them only for people earning less than $200,000 or families earning less than $250,000 per year (considered the middle class) while allowing them to expire for higher earners. That would mean that the marginal tax rate for the wealthy would be 39.6 percent, up from 35 percent. Tea Party groups are strongly in favor of extending the breaks. And many centrist Democrats, like outgoing Sen. Evan Bayh of Indiana, also back extension. Signs point to Democrats cutting a deal to keep the middle-class cuts in place, fulfilling a promise Obama made on the trail not to raise taxes on the middle class. A compromise might make the middle-class cuts permanent and temporarily--perhaps for two years--extend the breaks for the wealthy, essentially kicking the can down the road.

Theory: Acccording to the CBO, reducing employers' payroll taxes--either across the board or specifically for those who increase their payrolls by hiring--is one of the most effective stimulative policies the government can pursue. That was one of the goals of the HIRE Act, which was enacted in March 2010. Offering employers the tax break directly provides a hiring incentive.

Proponents: There hasn't been much discussion of further breaks since the HIRE Act, although former New York Stock Exchange chair Richard Grasso has spoken in favor of it. However, the preliminary report released by the chairs of the president's National Commission on Fiscal Responsibility and Reform actually suggests increasing the payroll tax. Democrats have been resistant to further credits; payroll taxes sustain Social Security, and skeptics worry that offering a break just brings the looming Social Security crisis closer. One alternative, backed by economist Karl Smith, is to offer a tax credit but to continue to put the money those taxes would have brought in into Social Security by cutting the federal budget elsewhere.

Theory: The left-leaning Economic Policy Institute calculates that every dollar spent on infrastructure produces $1.59 in economic benefit, making it a great investment: once projects are up and running, they employ construction workers, and they leave in their wake new engines of economic growth, such as efficient roads. Backers also point out that now is a good time to start projects because materials and labor are cheap, and interest rates are low. The CBO, however, says the effects would be almost exclusively felt in the long term. Infrastructure and transportation spending was a modest part of the stimulus bill passed early in President Obama's tenure--$68 billion of the total $787 billion.

Proponents: President Obama continues to propose spending on infrastructure, specifically calling for $50 billion in a September speech in Cleveland. Backers also argue that the full effects of the earlier transportation spending are not being felt. Republicans tend to be resistant to infrastructure spending, both because they're skeptical of mass-transit proposals like high-speed rail and because they're wary of the effectiveness of government spending in general. New Jersey Gov. Chris Christie, a Republican, recently canceled the nation's largest infrastructure project by saying his state couldn't afford its share. The lack of immediate effects from the stimulus has given roads and rail lines a bad name, aided by President Obama's recent admission that "there's no such thing as shovel-ready projects."

Theory: The White House says that offering tax breaks for companies that do innovative research would support job creation in the U.S. and increase certainty among businesses.

Proponents: At the same time that Obama announced his September infrastructure push, he also called for a permanent extension, worth $100 billion, of an existing temporary research and development tax credit. Such a plan is typically popular on both sides of the aisle, in large part because it lowers taxes. But the issue hasn't yet been taken up yet by Congress. Meanwhile, the preliminary deficit commission report also calls for making the R&D tax credit permanent.

Theory: Conservatives believe the health-care reform passed by Congress is hampering hiring. To guarantee tax revenue that funds the new health regime, the law requires strenuous disclosure of certain expenses on the 1099 tax form. But detractors of the law argue that that kind of paperwork sucks up time and money and depresses job creation. Some politicians have also claimed there will be massive tax increases as part of the law, which could harm job creation, although those fears are for the most part unfounded, according to the nonpartisan Web site Factcheck.org.

Proponents: Republicans have widely lined up behind a call to "repeal and replace" the bill, acknowledging that the current health-care system is unsustainably costly while still opposing the law the president signed. With Democrats still in control of the Senate and the presidency, however, repeal is seen as an unlikely prospect in the next two years. The Republican leadership has been vague about how repeal would work: the office of presumptive incoming Speaker John Boehner couldn't provide documentation for the employment effects of repeal. Conservative economists have generally argued that getting rid of regulations, including the health-care law, makes the economy more likely to grow. Meanwhile, though Democrats are similarly shy on details, they see two benefits to the law. One, the bill directly creates jobs in health care, though that doesn't address the impact of the law on the broader job market. Second, they point to a CBO estimate saying the bill will reduce the deficit, which is positive for the economy as whole. Republicans dispute the CBO figures. Most Democrats remain staunchly opposed to repeal, and the Senate rejected a bill loosening the 1099 requirement in September. Since the election, President Obama has also signaled a willingness to work on easing the provision. The deficit commission generally endorsed health-care reform as a positive step from a deficit perspective.

Theory: While humanitarian concerns are obviously a major reason for the social safety net, there's an economic theory behind it, too--putting money in the hands of the unemployed encourages consumption (not unlike tax cuts), which puts money into the private sector. According to the CBO, increasing unemployment assistance is one of the most effective methods of stimulating both employment and economic growth, in the short and long terms. But initial aid lasts for 26 weeks and requires emergency federal assistance to continue. Economists forecast a drop of as much as 0.4 percent in economic growth between December and February if benefits aren't extended during the lame-duck congressional session.

Proponents: Most Democrats support an additional extension; a bill was introduced in the House in August but is stalled (previous extensions have been contentious). Some conservatives oppose aid because, as economist Bartlett puts it, "They just think that half the unemployed are just lazy." There's also a moderate center, represented by politicians like Sen. Ben Nelson, a Democrat, and Keith Hennessey, an economic adviser to President George W. Bush, that believes benefits should be extended but the cost should be offset by budget cuts elsewhere. But harder-line liberals like Paul Krugman argue that the government shouldn't cut any spending until the economy has recovered.

Theory: It's a central tenet of conservative thought that smaller government encourages economic growth. In the present, that's compounded by widespread concerns about the size of the federal deficit, which looms over the economy and causes worry and uncertainty. Indeed, with deficit concerns at the forefront of the public mind, it's likely that there will be spending cuts.

Proponents: Republicans and conservative economists say that only by getting out of the way can the government facilitate growth, making them leading advocates of cutting federal spending. The problem, however, is that the largest portions of the federal budget come from two political sacred cows: defense and entitlements. Many Republicans and some Democrats have said they're unwilling to cut defense spending, while both parties fear cutting Social Security (one look at the demographics of voters in the midterms shows why: seniors are far more avid voters, and they're understandably protective of their Social Security checks). And some economists on the center and left object to cuts on policy grounds. Bartlett, for example, worries that cutting spending now would echo spending cuts in 1937, which nearly destroyed America's nascent recovery from the Great Depression (World War II blunted the effects of the failed policy). And those to the left of Bartlett are even more adamant.

Theory: With most fiscal policy options frozen up by partisan bickering, all eyes are on the Federal Reserve to make changes through monetary policy. But the Fed's hands are tied, too: although lowering the federal-fund interest rates is a favorite strategy for the Fed, the rate is essentially zero already. As a result, the Fed has recently embarked on a round of quantitative easing. In essence, QE creates money by buying up government bonds, which puts cash into circulation. That lowers long-term interest rates and, in theory, spurs economic growth in the long term. As immediate job creation, it's unclear how effective it might be.

Proponents: This is the Fed's rodeo, but the policy has plenty of detractors. Foreign countries, in particular, object to the move as devaluing the dollar, which could give the U.S. an advantage on exports. That put President Obama in a tough spot at the recent G20 meeting. But with political deadlock in Washington, there aren't many other options for getting the nearly 15 million Americans who are jobless back into the workforce.