AN ALTERNATIVE STIMULUS PLAN / THE WALL STREET JOURNAL OP EDITORIAL ( RECOMMENDED READING )

OPINION

NOVEMBER 18, 2009

An Alternative Stimulus Plan

By Michael J. Boskin

While the economy has finally started to grow, the disturbingly high unemployment rate is increasing pressure from the left to double down on this year's poorly designed fiscal stimulus. Since the stimulus bill was signed, the ranks of the unemployed have grown by over three million (over four million if involuntary part-time and discouraged workers are included). The unemployment rate, which the Obama administration projected the stimulus would contain at 8%, is now 10.2%.

There is little likelihood that another round of similar fiscal stimulus would yield much more than the paltry return on the first one. The original transfer payments and tax rebates barely nudged consumer spending, and the federal spending has been painfully slow. The delayed infrastructure spending—the shovels are still in the shed—will have a bigger impact, though less than claimed. Some of the funds to state and local government did reduce layoffs. The stimulus bill surely ranks dead last compared to the natural dynamics of the business cycle, the Fed's zero interest rate policy, and the automatic stabilizers in the tax code (which have reduced taxes proportionally more than income) as far as explanations for the improvement in the economy.

But to evaluate the stimulus properly we should consider not just what we got for the $787 billion cost but the effects of alternative policies that might have been enacted.

My Stanford colleague Pete Klenow and Rochester economist Mark Bils estimated that cutting the payroll tax by six percentage points (of the 12.4% Social Security component) would, under standard assumptions, increase employment by three million to four million workers—an amount equal to all the job losses since the stimulus was passed.

The payroll tax cut would have reduced firms' costs by roughly the same amount as from the entire decline in employment. It would have cost less than half as much as the stimulus bill, gotten far more income into paychecks quickly and, most important, greatly reduced incentives for firms to lay off workers. In fact, it would have created incentives to hire.

Even using the administration's claims of one million jobs "created or saved," the stimulus program passed in early February is millions of jobs short of what a cheaper payroll tax suspension would have delivered.

Yet the president and Congress are preparing vast new taxes on employment in the health-care reform and other legislation. Raising the federal top tax rate to 45% (from the current 35% with a 5.4% surcharge plus the expiration of the Bush tax cuts) will hit successful small businesses especially hard. The tax hike on capital gains and dividends hidden in the fine print of the health-care legislation will also raise the cost of equity capital, further weakening businesses (including banks) desperate for private capital. Many firms will also face either an 8% additional payroll tax or be forced to pay a higher share of health insurance premiums. Such tax increases will hit employment and wages hard.

It would be far better to junk part of the remaining stimulus in favor of a one-year partial payroll tax cut. Also accelerate spending that needs to be done eventually, such as replenishing depleted military equipment used up in Iraq and Afghanistan and adding a desperately needed two Army brigades.

There are five large interrelated headwinds to jobs and growth. First, continued deleveraging, unresolved toxic assets and weak banks are constraining credit, especially for small business that is the source of most hiring. Second, household balance sheets depressed from declines in home values and portfolios are likely to constrain consumption growth. Third, government industrial-policy micromanagement with subsidies and mandates from pay to products is forcing noncommercial decisions on wide swaths of the economy from financial services and autos to energy and health care. Such policies have never worked before—ask the Japanese, Koreans and Europeans. Fourth, the explosion of spending, deficits and debt foreshadows even higher prospective taxes on work, saving, investment and employment. That not only will damage our economic future but is harming jobs and growth now. Fifth, the massive liquidity injections by the Fed raise the specter of future inflation.

By far the best response to these headwinds is to curtail the huge current and contemplated future government control of the economy with a clear, predictable exit strategy—before the programs become permanently entrenched, develop powerful dependent constituencies, and greatly increase the risk of rising interest rates, inflation and taxation. Doing so would more rapidly improve the outlook for permanent private-sector employment, investment and growth than any conceivable second stimulus. It would also allocate capital and labor to their highest value in providing goods and services that people actually want and need, not what government bureaucrats want them to have.

The jobs agenda must begin with a Hippocratic oath: First do no harm to employment. That means jettisoning or at least delaying job-killing energy and health-care legislation with their mandates, taxes and costs that especially hammer small businesses.

Also wind down, as soon as possible, the emergency measures which healthy businesses, households and investors fear will become permanent competitive impediments. Start with the Troubled Asset Relief Program, which the Treasury uses as a permanent revolving fund even for nonfinancial bailouts.

Financial regulation should focus on disclosure, transparency, effective clearing, capital adequacy and new bankruptcy procedures. We also need a Plan B, modeled on the Resolution Trust Corporation cleanup of the savings and loans, in the event the losses on toxic assets are too large for time, profitability and economic recovery to manage. And the Fed must forestall future inflation by withdrawing its immense liquidity injections as soon and predictably as feasible (its initial steps are commendable).

Finally, if possible, we should complement these pro-employment policies with long-run fiscal reform: control entitlement cost growth, e.g., with price rather than wage indexing of Social Security, and real tax reform with the widest possible tax bases and lowest possible rates. America's corporate tax rate, the second highest among advanced economies, is especially damaging.

That is a far more consistent common-sense recipe for more and better jobs, far sooner than the current contradictory and ineffective policy mess emanating from Washington.

—Mr. Boskin is a professor of economics at Stanford University and a senior fellow at the Hoover Institution. He chaired the Council of Economic Advisers under President George H.W. Bush.

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