A Recovery Stymied by Redistribution

Public policy intended to make layoffs less painful actually made layoffs cheaper and more common.

unemploymentby Casey B. Mulligan

Why has the labor market contracted so much and why does it remain depressed? Major subsidies and regulations intended to help the poor and unemployed were changed in more than a dozen ways—and although these policies were advertised as employment-expanding, the fact is that they reduced incentives for people to work and for businesses to hire.

You probably heard about the emergency-assistance program for the long-term unemployed that ended only a few months ago after running for almost six years. But there is also the food-stamp program. It got a new name and replaced the stamps with debit cards. Participants are no longer required to seek work and are not asked to demonstrate that they have no wealth. Essentially, any unmarried person can get food stamps while out of work and can stay on the program indefinitely.

There were new mortgage-assistance programs. People who owed more on their mortgage than their house was worth could have their mortgage payments set at a so-called affordable level—in government-speak, that means that you pay full price for your house only if you have a job and earn money.

There were new rules for consumer bankruptcy, with special emphasis on the amount that consumers were earning after their debts were cleared.

All of these programs have in common that they, like taxes, reduce incentives to work and earn. The cornerstone of “The Redistribution Recession” is to quantify the sum total of these incentives and their changes over time. That’s what I call the marginal tax rate, by which I mean the extra taxes paid, and subsidies forgone, as the result of working. Waves of new programs increased the typical marginal tax rate from 40% to 48% in two years.

There is a real demand for this kind of redistribution. Helping people who are unemployed or with low incomes is intrinsically valuable. We like doing it, and we like knowing that a system of help is there if we need it.

This demand fluctuates over time. Democrats had quite a streak of winning federal elections: taking the House and Senate in 2007 and then winning the White House twice in a row.

Even if somehow Democrats hadn’t won these elections, we would still have had redistribution in a crisis. For most of our lifetimes, middle-class people did not imagine themselves participating in, say, the food-stamp program, and understandably were not particularly supportive of expanding it. But 2008 was different, and for the first time lots of people were thinking about what might happen if their family suddenly became poor or unemployed.

Helping people is valuable but not free. The more you help low-income people, the more low-income people you’ll have. The more you help unemployed people, the more unemployed people you’ll have.

That’s a cost. For example, you have people out of work who would be productive if it weren’t for the help. So there’s a trade-off: more help, less economic efficiency.

I met a recruiter—a man whose job it is to find employees for businesses and put unemployed people into new jobs—and he described the trade-off pretty well. Stacey Reece was his name, and he said that in 2009 his clients again had jobs to fill. But he ran into a hurdle he hadn’t seen before. People would apply for jobs not with the intention of accepting it, but to demonstrate to the unemployment office that they were looking for work.

As Mr. Reece described it, the applicants would use technicalities to avoid accepting a position. The applicants would take Mr. Reece through the arithmetic of forgone benefits, taxes, commuting costs and conclude that accepting a job would net them less than $2 per hour, so they’d rather stay home.

People remain unemployed longer, as Mr. Reece saw with his own eyes.

Friedrich Hayek’s “Use of Knowledge in Society” explains how economic information is not and cannot be fully known by a single person. That information exists “solely as the dispersed bits of incomplete and frequently contradictory knowledge which all the separate individuals possess.” Mr. Reece is one of those separate individuals. Most policy makers were not and are not aware of what Mr. Reece was seeing. Most of those who voted Democrats into the Senate, the House and the presidency were not aware.

But as Hayek would tell you, it’s not simply a matter of putting Mr. Reece in charge. It’s impossible for me or anyone else to tell you all of the things that Mr. Reece doesn’t see, but let me name three. First, Mr. Reece doesn’t mention many other new and expanded programs with the same economic character, such as food stamps, mortgage assistance or health-insurance subsidies.

Second, Mr. Reece’s perspective comes with some judgment; his story makes the unemployed seem a bit lazy or ungrateful. But you could just as well say that this situation arises from the employer’s failure to up his bid so that it competes better with unemployment benefits. My point here is not to assign fault but to illustrate that a lot of different actors contribute to market outcomes.

Third, Mr. Reece is in charge of hiring, not firing. If we had more time to look at what businessmen had to say about the government’s fiscal stimulus, I would show you statements from those making decisions about layoffs. They explain how the new and expanded programs for the unemployed and poor were subsidizing layoffs—they were making layoffs cheaper.

Unlike state unemployment-insurance benefits that are sometimes a kind of liability for the employer writing the pink slip, the federal unemployment-insurance expansions were paid by taxpayers generally, which means that an employer could lay off as many people as he wanted without adding to his federal tax burden.

Maybe more vivid was the kind of ObamaCare experiment in the American Recovery and Reinvestment Act of 2009 that told unemployed people that “if you like the health plan you had on your old job, you can keep it,” and the federal government will pay. Before the Recovery Act, many employers used to voluntarily help employees with their insurance after a separation; these were expensive benefit programs for their employees. The employers had to consider that laying somebody off was going to end the value created by the employee but wasn’t going to end the health expenses the employee creates. But employers readily explain how the Recovery Act completely changed that calculus. Lay somebody off during the crisis and, for the first time, among other things, the employer wouldn’t have to pay for former-employee health insurance.

So public policy intended to make layoffs less painful actually made layoffs cheaper and more common.

It’s not just politicians or journalists who do not see the full economic picture. It’s the top economists in the world, from the International Monetary Fund to university professors, who promised that there was no trade-off and that, at this supposedly special time in history, redistribution would create jobs and grow the economy. The stimulus advocates rarely note the kind of thing that Mr. Reece talked about, and they never, ever, mention that redistribution is a subsidy to layoffs.

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Casey B. Mulligan is an economics professor at the University of Chicago. This article was published at The Wall Street Journal and is adapted from remarks by Mulligan on receiving the Hayek Prize on June 25 from the Manhattan Institute for his book “The Redistribution Recession”.