Today's Economist: Casey B. Mulligan: A Budget for Regulation

Casey B. Mulligan is an economics professor at the University of Chicago. He is the author of “The Redistribution Recession: How Labor Market Distortions Contracted the Economy.”

As Democrats and Republicans haggle over federal taxes and spending, another important policy tool gets less attention: regulation.

Perspectives from expert contributors.

Government has a variety of ways it can achieve its objectives, including subsidies, taxes and regulation. For example, the government might attempt to help disabled people by subsidizing handicapped-accessible buildings. Or it could levy an extra tax on buildings that are not handicapped-accessible. Or it could simply refuse to permit structures to be built, or used in various situations, without being handicapped-accessible.

All three strategies are likely to affect building activity, increase the prevalence of handicapped-accessible buildings and in so doing help people with disabilities, as intended. The first strategy is ordinarily called government spending; the second, taxation; and the third, regulation.

Private-sector activities to comply with regulation do not appear in the government budget, whereas private-sector interactions with tax and spending programs do, in terms of the amount of money they pay or receive. (Regulation does need a government budget for enforcement, but so do taxes and spending, and enforcement is distinct from the private sector’s compliance activities.)

Politicians have devised various budgetary gimmicks to help disguise what they tax and spend, and the sunset provision that led to next month’s fiscal cliff is one of them. Nevertheless, experts and even the voting public get an idea of the importance of taxes and spending in the economy by looking at budget totals and perhaps a few of the largest line items.

The same cannot be said for regulation, which lacks any official budget. Attempts have been made to quantify regulation by the number of pages of law or pages of agency rules: President Ronald Reagan once bragged that his administration reduced one area of regulation to 31 pages from 905.

However, pages can be misleading, because some words, sentences and paragraphs have more impact than others. For example, some laws, like those requiring children to attend school, have little impact because a vast majority of American families would send their children to school even if the law did not require it. Other laws, like many curfews, take up space on the books but are not enforced.

Because regulations have so far been poorly quantified, it is interesting to see a recent study of workplace regulation by complianceandsafety.com. It attempts to measure the aggregate of importance of workplace regulation by the dollar amount of fines collected by the Occupational Safety and Health Administration. Its chart, reproduced below, looks at the fines in reverse chronological order, and colors years according to the political party of the president in power.

complianceandsafety.com

OSHA fines have increased sharply since 2009. Perhaps more surprising is that the largest fine increases previously were under a Republican president (the first President George Bush) and the largest reductions were under President Bill Clinton.

As with taxes and spending, we cannot necessarily conclude that more regulation is “bad” or “good,” but it would be helpful for experts and voters alike to see a rigorous accounting for government regulation.

Today's Economist: Casey B. Mulligan: Employer-Provided Health Insurance and the Market

Casey B. Mulligan is an economics professor at the University of Chicago. He is the author of “The Redistribution Recession: How Labor Market Distortions Contracted the Economy.”

The future of employer-provided health insurance is better considered together with the future of total employee compensation, both cash and fringe benefits like health insurance. From that perspective, the likelihood that most employers will continue to offer health insurance is not necessarily good news for employees.

Perspectives from expert contributors.

The Patient Protection and Affordable Care Act, President Obama’s initiative, offers large health-insurance subsidies to the majority of the population beginning in 2014, but only if their employer does not offer affordable insurance. The subsidies are frequently much larger than the subsidies coming through the tax exclusion of employer-provided health insurance.

Some economists are predicting that eligible employees, especially those in line for the largest subsidies, will prefer employers who do not offer affordable insurance. As a result, they say, many more employers will not offer insurance.

Others have different expectations, pointing out that employers dropping insurance will pay penalties and throw away the tax exclusion for their employees who are not subsidy-eligible (typically the ones who earn more). Moreover, perhaps because people are comfortable with their existing coverage even if it is not subsidized, employer coverage did not decline in Massachusetts when it began a similar plan (by my estimate, only 5 percent of the people in Massachusetts who could get subsidized individual-market insurance actually receive it, largely because they have coverage through the employer of the head of the household or that person’s spouse). Note that Massachusetts has lower subsidies and a narrower eligible population than the Affordable Care Act and lower employer penalties for dropping coverage.

How many employers will drop their coverage when the new health care law gets under way? The answer makes for a nice headline, but that’s the wrong question. Would it be so bad if many employers dropped their coverage but replaced it with huge cash raises? Or would it be so good if every employer continued to offer coverage but required employees to take big pay cuts?

All sides agree that some otherwise subsidy-eligible employees will work for employers that keep their coverage, and other subsidy-eligible employees will work for employers that drop it. Market forces must be considered, because some employees will be moving between these two types of employers.

Low-income employees will ultimately cost less to employers without coverage (or without “affordable” coverage; the important issue is that their low-income employees are subsidy-eligible) than they cost to employers with coverage. If they didn’t, low-income employees would be better off at employers without coverage and would line up to work there. Meanwhile, the employers with coverage would find it more difficult to retain and attract low-income employees. That situation defies supply and demand.

Another way to see the same result: by getting low-income employees at lesser cost, employers without coverage can, without going out of business, compete aggressively for the high-income employees who are considering positions that offer coverage.

By the same logic, high-income employees will cost more to employers without coverage than they do to employers with coverage. Thus, high-income employees will lose one way or another — either they will lose their tax exclusion because their employer eliminates coverage or they will see their cash compensation fall below what it would have been without the Affordable Care Act.

At the same time, the low-income employees will enjoy the subsidy either way: either their employer drops coverage, in which case they receive the subsidy directly, or their employer increases their compensation above what it would be without the Affordable Care Act to attract them from the employers without coverage. Tax economists will recognize this as the Harberger model applied to the Affordable Care Act; international economists will recognize it as the Heckscher-Ohlin model.)

The same sorts of market competition will ultimately prevent most employers from dropping their coverage and thereby incurring the penalties. Employers keeping coverage will raise the pay of subsidy-eligible employees and get by with fewer of them. Those who remain will typically not want to leave for no-coverage employers because doing so would cut their pay. The same employers will hire a few more high-income employees at lesser pay, because for those employees, the alternative is a no-coverage employer.

Today's Economist: Casey B. Mulligan: A Keynesian Blind Spot

Casey B. Mulligan is an economics professor at the University of Chicago. He is the author of “The Redistribution Recession: How Labor Market Distortions Contracted the Economy.”

The decline of home construction is not the primary reason that our labor market remains depressed: Keynesian policies are.

Perspectives from expert contributors.

If we accept that the housing sector was overbuilt by 2006, then it might seem inevitable that a recession would follow as the housing sector downsized, workers shifted from construction to other industries and workers moved from overbuilt regions to other places in America.

But as Paul Krugman points out in his “End This Depression Now!” the recession of 2008-9 did not have many industries that were growing, let alone growing as a consequence of reallocation away from home construction.

Moreover, transitions between industries and regions have happened before, but happened gradually as demographic and other trends slowly but powerfully altered the composition of economic activity. By comparison, this recession came on suddenly.

To put it another way: for every worker that construction lost between 2007 and 2010, the rest of the economy lost at least another five workers, rather than gaining workers. I agree with Professor Krugman and other opponents of the “sectoral shifts theory” that something must have happened — in less than a year or two — that profoundly affected practically all industries and practically every region.

But just because sectoral shifts are at best a small part of what happened does not mean that huge government subsidies would take the labor market back to what it was before the recession. A Keynesian-style demand collapse is not the only aggregate event that could happen or did happen.

In my new book, I explain how, in the matter of a few quarters of 2008 and 2009, new federal and state laws greatly enhanced the help given to the poor and unemployed — from expansion of food-stamp eligibility to enlargement of food-stamp benefits to payment of unemployment bonuses — sharply eroding (and, in some cases, fully eliminating) the incentives for workers to seek and retain jobs, and for employers to create jobs or avoid layoffs.

Economists normally think that eroding incentives (as they call it, raising marginal labor income tax rates) depresses the labor market rather than expanding it, and that it would be tough for the labor market to get back to its 2007 form without returning incentives to what they were back then.

Yet Professor Krugman asserts that he would end this depression now with an even bigger stimulus — with more help for the poor and unemployed — that would further erode incentives and further penalize success.

Remarkably, “End This Depression Now!” says nothing about marginal tax rates or incentives to work, either as they actually evolved or as they would appear in Professor Krugman’s ideal stimulus. Nor does the book explain why economists or anyone else should ignore sharp marginal tax-rate increases, or why paying people for not working would have nearly the expansionary effect of military buildups and the like. (These absences are conspicuous to economists who are familiar with Professor Krugman’s academic work on how excessive debts harm debtor incentives.)

“End This Depression Now!” is full of interesting and relevant observations, but don’t expect its author to mention, let alone appreciate, a non-Keynesian explanation for any of them.

Today's Economist: Casey B. Mulligan: Measuring Employer Confidence

Casey B. Mulligan is an economics professor at the University of Chicago. He is the author of “The Redistribution Recession: How Labor Market Distortions Contracted the Economy.”

The labor market effects of employer confidence are probably real but have been exaggerated.

Perspectives from expert contributors.

American employers have hired more than 230 million times since the recession began, but need to hire even more for employment per person to return to what it was five years ago.

One explanation for this state of affairs, according to the Mitt Romney campaign, has been a supposed lack of confidence among employers who are worried about taxes and new regulations, especially those associated with the Affordable Care Act (often referred to as Obamacare) as it is fully put in effect.

It is easy to find a businessman worried about government intervention, but the prevalence of such worries does not by itself tell us whether a lack of employer confidence depresses employment 10 percent, 1 percent or 0.1 percent.

Presumably if we have two employers who can hire workers at $20 an hour for the same task, the more confident of the two will hire more people than the less confident one, all else being the same. To put it another way, the less confident employer will require a greater immediate profit from his next $20-an-hour hire than the more confident employer, to compensate the less confident employer for the extra tax and regulatory costs associated with the hire that he anticipates in the future.

To the degree that an erosion of employer confidence has depressed the entire labor market, we should see the immediate profit from employees grow over time, as employers perceive more tax and regulatory costs on top of the cash and fringes they already owe their employees.

The gap between labor productivity and inflation-adjusted employee compensation is one way that economists measure the immediate profit from hiring, because the immediate benefits of hiring come from the production of the workers and the immediate costs include the employees’ compensation. (This measure is also sometimes called the “inverse of real unit labor cost.”)

The chart below shows indexes of labor productivity (red) and inflation-adjusted hourly employee compensation (black) since the recession began. Both indexes are measured after taxes and employee subsidies according to single marginal tax-rate series, so their gap reflects changes in the immediate profit from hiring. (For more information on these measures, see my previous post and my recent book on the labor market since 2007.)

About the time the Affordable Care Act was debated, after-tax productivity began to recover, and more quickly than after-tax real wages did. By the end of 2011, wages had still not recovered as much as productivity had.

(Another issue potentially depressing wages more than productivity is the anticipation of a new-employee tax credit, like the one proposed by President Obama in September 2011 and seriously discussed as early as 2009 and analyzed on this blog.)

Something prevented wages from keeping up with productivity, and perhaps eroding employer confidence is part of the story. But even if employer confidence were the whole story, it still explains less of the labor-market depression than do taxes on employees and subsidies for people who do not work. In early 2010, for example, after-tax real wages had been depressed more than 11 percent, of which only two percentage points were because of a failure of wages to keep up with productivity.

As I explained in a previous blog post, subsidies for people not working are the primary reason that wages fell so much after taxes and subsidies.

It would be incorrect to attribute all of the deviation between productivity and wages to employer confidence. A change in the composition of demand in the direction of less labor-intensive industries would have a similar effect, even if employer confidence had remained constant. New Keynesian economists also blame some of the deviation on a failure of employers to adjust their prices fully to their production costs.

Moreover, it is possible that employer fears of future regulatory and tax costs would not depress employment even while they depressed wages to the degree that employees eagerly anticipate benefits they would receive from those regulations and taxes.

While traces of eroded employer confidence are seen in labor market outcomes, it also appears that eroded employer confidence explains less than one-quarter of the overall depression of the labor market.

Today's Economist: Casey B. Mulligan: The Rise and Fall of Wages

Casey B. Mulligan is an economics professor at the University of Chicago.

Aggregate wage-rate data show no sign of the huge and prolonged demand shock said to have hit the economy in 2008. Instead, they bear the fingerprints of an expanded social-safety net.

Perspectives from expert contributors.

A conventional narrative of the American labor market since 2007 is that the demand for labor collapsed, so that despite a uniformly willing and eager work force, millions of people had to go without jobs. This narrative is an aggregate theory and not primarily about sectoral shifts that would depress demand for some types of labor and increase it for others. If this narrative is accurate, it should be visible in aggregate wage-rate data.

At a minimum, the aggregate demand collapse should have frozen wage rates in dollar terms, so that inflation-adjusted wages would erode with inflation as consumer prices crept up. With the price index for consumer items 8 percent higher at the end of 2011 than it was when the recession began, inflation-adjusted hourly wages should have fallen at least 8 percent over that time frame, if not more.

In my view, the change in aggregate demand has been heavily exaggerated, and the greater impulse affecting the labor market over the last five years has been higher marginal tax rates created by an expanding social safety net of unemployment insurance, food stamps, Medicare and other anti-poverty programs. Those tax rates, as I noted last week, refer “to the extra taxes paid, and subsidies forgone, as a result of working, expressed as a ratio to the income from working.”

I expected real wage rates (and hourly labor productivity) to rise in the short term, and to do so a couple of percentage points above the previous upward trend made possible by continuing progress of the productivity of labor and capital.

Marginal tax rates increase real wage rates a few percentage points in the short term because, with more help during unemployment, employees at struggling businesses have less reason to make some of the concessions in wages and working conditions that can help the employer to retain employees affordably.

As I explain in “The Redistribution Recession,” wage rates would quickly fall back toward the trend line when some of the temporary safety-net measures began to expire, which was two or three years after the recession began.

Those safety-net expansions that were permanent would eventually reduce average real wage rates, as people out of work reduced their human capital investment. This reduction might reflect people who, because they no longer practice a trade, lose contacts in the workplace or no longer maintain a wardrobe or tools they need for work. (For more on this effect, see especially the literature on women’s wage trends.) Unfortunately, these wage reductions do not encourage employers to hire because they derive from reductions in productivity.

The black series in Chart 1 below shows aggregate real wage rates measured as inflation-adjusted employee compensation (including fringe benefits like health insurance) per hour worked. I have removed an upward trend, because for short-run analysis it is interesting to look at deviations from trends. Under normal conditions real wages can increase with productivity even while the amount of labor is neither rising nor falling.

The trend adjustment is 0.5 percent a year, based on the average rate of growth of total factor productivity during the four years before the recession. Without the trend adjustment, the black series would increase two percentage points more through 2011 than shown.

The chart also shows in red the marginal tax rate on labor income measured in my book for a typical household head or spouse based on the ever-changing eligibility and benefit rules for safety-net programs. Sure enough, real hourly compensation increased during the recession and did so about a quarter after marginal tax rates began their increase.

Marginal tax rates were high and fairly flat during 2009 and early 2010 as the “stimulus” law was in full force. During this time, real wages failed to fall back anywhere close to their prerecession values. Only when some of the stimulus provisions began to expire, reflected in a marginal tax rate that falls to 44 or 45 percent from 48 percent, did real wage rates decline quickly and significantly.

Even after the decline in late 2010 and early 2011, it looks as though real wage rates are about where the previous trend line was, rather than being the several percentage points below what one might expect after a huge, prolonged demand shock.

A few economists have used Census Bureau wage data, which ignore the fringe benefits from employment, to show that wages fell during 2010 and 2011. It is incorrect to ignore fringe benefits (I discuss this and other wage measurement issues in Chapter 2 of “The Redistribution Recession”), but the choice of series is just a quibble, because none of the aggregate wage measures display a cumulative decline that would be commensurate with the huge, prolonged demand collapse said to have occurred.

A magnifying glass is not required to see a decline in after-tax real wage rates. The after-tax real wage rate (calculated as the product of real hourly compensation and one minus the marginal tax rate shown in black in Chart 2), reflects the net financial reward per hour of working, taking into account taxes and safety-net subsidies.

The after-tax real wage series has been adjusted for a trend of 0.5 percent a year.

Marginal tax-rate changes, such as those created by an expanding social safety net, cause deviations between the real hourly compensation shown in Chart 1 and the after-tax series shown in Chart 2. In theory, the downward marginal tax rate effect on after-tax real wages exceeds the upward effect on real hourly compensation.

In fact, after-tax real wages fell a startling 12 percent below the trend line during the first two years of the recession (note that each tick in Chart 2 is twice as large as each tick in Chart 1). They rebounded somewhat as marginal tax rates came off their stimulus highs but still remain six or seven percentage points below the trend line.

The quantity of labor — hours worked per capita including zeros for people not working – is shown as a red series in Chart 2. Remarkably, labor and after-tax real wage rates collapse together, hit bottom together and exhibit a partial recovery together.

Helping the poor and unemployed is intrinsically valuable, but is not free. It has made labor more expensive and depresses employment.