Some have argued that tax cuts for businesses would quickly help address the nation's high unemployment rate. On the surface, the idea of lowering the overall costs of employment as a means of creating incentives for firms to hire new people sounds attractive. Unfortunately, the dynamics behind the current recession argue otherwise.
1. The lack of hiring is not due to high costs of employment, but sluggish demand for products and services. Employment costs have risen very slowly in the past year, so workers have not suddenly become 'unaffordable' for businesses to retain or hire so to speak.
A combination of data ranging from a sluggish recovery in real personal consumption expenditures, declining consumer credit/household deleveraging and considerable slack when it comes to capacity argues that the lack of hiring necessary to lower the nation's unemployment rate stems from reduced demand for products and services. Businesses have no pressing need to embark on an expansionary phase when aggregate demand is weak. Therefore, sustained economic growth during which demand for businesses' products and services increases, not tax cuts, would be far more likely to lead to a meaningful recovery in the employment market.
In fact, if one looks at the tax relief provisions of the $787 stimulus package, one finds that tax incentives to encourage consumption and tax incentives to fuel hiring were largely ineffective. The majority of tax relief aimed at increasing consumption was saved not spent. According to Professor Nouriel Roubini's RGE Monitor, the more than $6.0 billion in tax incentives provided in the $787 billion stimulus package for firms to hire disadvantaged workers did little to boost hiring.
2. Given the experience with the fiscal stimulus' tax cuts, arguably the weakest part of the package, and the recession's having been driven by a shock to aggregate demand (not aggregate supply), the benefits of corporate tax cuts would be far more likely to contribute to firms' bottom lines than renewed hiring. Given considerable public disdain for the financial- and automotive-sector bailouts, it is not very likely that the use of the tax code to boost corporate profits at a time of subdued hiring would be politically popular. The political realities associated with direct bailouts may well have contributed to lawmakers providing a
$10.4 billion "backdoor bailout" rather than direct one to companies in the just-enacted jobless benefits extension law by allowing them to apply their 2008-2009 losses to any five years prior to 2008, with some modest limitations. The provision is a backdoor bailout, albeit a modest one, because under current law, the loss carryback extended to two years and some of those firms would not have benefited without the expanded carryback period.
3. On grounds of fiscal discipline, such tax cuts would also be problematic. At a time when public debate over the nation's burgeoning fiscal deficit has sharpened, revenue and/or spending offsets for any tax cuts would be necessary to avoid worsening the nation's budget deficits. Moreover, to the extent that "temporary" tax cuts become permanent, the nation would experience an increase in its structural budget deficits. Examples, including regular waiving of tiny Medicare spending restraints aka the "doctors's fix" and past extensions of "temporary" spending increases/tax cuts, illustrate a real policy-driven risk that cyclical increases in the budget deficit could be transformed into structural ones.
4. The steady increase in the mean and median duration of unemployment and possibility that select sectors (finance, real estate, and automobile manufacturing) could wind up smaller through at least the medium-term than they were prior to the recession points to a larger structural component to unemployment in recent years. Tax cuts will not change the structural dynamics. Investments in education would probably do more to shift skills to where the labor market is evolving, but such investments would be longer-term in nature. They would not immediately result in a significant reduction in the unemployment rate.
In sum, hiring will increase once companies are confident in a sustained and durable economic recovery. That will take some time, namely it will require economic growth to be reasonably robust and sustained for the time necessary for businesses to see demand for their products and services increasing to the point that they need to hire additional people and for employers to be confident that the trend will continue. Before then, the unemployment rate could continue to climb into at least the first part of next year and then slowly decline, largely due to the number of layoffs decreasing relative to a low-level of hiring.