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2011.03.24 Employment and the Government Tax Wedge

2011.03.24 Employment and the Government Tax Wedge

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Published by: dave_jamieson1222 on Oct 28, 2011
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2909 Poston Avenue, Second Floor, Nashville, TN 37203 (615) 320-3989 FAX (615) 320-3806
128,000130,000132,000134,000136,000138,000140,0003,500,0003,600,0003,700,0003,800,0003,900,0004,000,0004,100,0002006 2007 2008 2009 2010 2011
By Arthur B. Laffer Ph.D., Ford Scudder CFA and Wayne Winegarden Ph.D.
Recent employment reports are showing increasing job gains and decreasing new unemployment claims. Many marketparticipants believe that the job gains are the beginning of a virtuous cycle with strong economic growth and furtheremployment growth reinforcing each other to create a strong recovery. We do not fall into that camp. Instead, we continue tobelieve that, barring any major exogenous shocks, we will see real economic growth on the order of 2% to 3% for the nextfew years.And, when you really look at the employment numbers, it is hard to take comfort in anything you see. While it is true theunemployment rate has fallen, the decline is not based on a huge surge in employment (Figure 1), but is due in part to adecline in the size of the labor force or, alternatively stated, an increase in the number of discouraged workers.
Figure 1
Total Weekly Hours and Total Non-Farm Payrolls
(monthly, thousands, SA, through Feb-11)
Source: BLS
Without growth in the quantity of labor supplied, the only way the economy can grow is via productivity growth. For instance,throughout 2009 as employment was still collapsing, productivity growth soared (Figure 2). Yet generating long-term
10-yr T-Note: 3.41% DJIA: 12,170.56 NASDAQ: 2,736.42 S&P 500: 1,309.66 S&P 500 Undervalued: 120.8%
Supply-Side Investment ResearchMarch 24, 2011
The past few months have produced positive employment reports, but these merely scratch the surface of a severelydepressed labor market.
A significant reduction of the government tax wedge could prevent the U.S. from experiencing an elongated highnatural rate of unemployment as in the euro-zone.
The Federal Reserve’s mandate as well as reelection considerations will drive monetary and fiscal policy, inevitablyresulting in inflationary pressure and a continued slow growth economy.
The failures of the current government will create the opportunity for pro-growth reforms in 2013.
Total Weekly Hours (LHS)Total Non-farm Payrolls (RHS)
Laffer Associates Employment and the Government Tax Wedge
-4%-2%0%2%4%6%8%10%-4%-2%0%2%4%6%8%10%2006 2007 2008 2009 2010 201192949698100102104106108929496981001021041061080 5 10 15 20 25 30 35 40 45
   E  m  p   l  o  y  m  e  n   t   (   %   o   f   P  e  a   k   )
Months Past PeakBestWorstCurrent
productivity growth above its historical mean is very difficult—and indeed productivity growth slowed over the second half of2009 before going negative in the second quarter of 2010. Productivity growth has since recovered to slightly above its long-term historical mean.
Figure 2
Productivity Index Growth: Output per Hour for Non-farm Business
(quarterly, annualized % change from a quarter below, through Q4-10)
Source: BLS
The current economic recovery remains the worst on record as measured by the level of employment growth (Figure 3). Notonly is employment well below the next worst cumulative result for recessions since 1940, but the current rate of employmentgrowth is abysmal as well. Meanwhile, the apparent improvement in the unemployment rate as of late is due to the declininglabor force—an unhealthy sign for the economy. Figure 4 shows the actual unemployment rate from its peak in October 2009compared to the unemployment rate as it would have been had the labor force not contracted. If the labor force had stayedthe same size from the peak in the unemployment rate until now, the unemployment rate would be 9.4%. These are notnumbers that put the economy in a good light.
Figure 3
Employment - Path from Peak
(2007.12 – 2011.02 vs. Max & Min For All Recessions, By Month, Since 1947)
Source: Federal Reserve Bank of St. Louis, BEA
Laffer Associates Employment and the Government Tax Wedge
8.0%8.5%9.0%9.5%10.0%10.5%11.0%8.0%8.5%9.0%9.5%10.0%10.5%11.0%Oct-09 Dec-09 Feb-10 Apr-10 Jun-10 Aug-10 Oct-10 Dec-10 Feb-11Unemployment RateConstant WorkforceUnemployment Rate3%4%5%6%7%8%9%10%11%20304050607080901001981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011Bush Clinton BushObamaReaganUnemploymentRate (RHS)Approval (LHS)
Figure 4
Official Unemployment Rate vs. Unemployment Rate with Constant Labor force
(monthly, through Feb-11)
The focus will remain on the employment picture for the foreseeable future due to its central role as a barometer of theeconomy’s health.For politics, historically presidential polling numbers are inversely correlated with the unemployment rate (Figure 5).
We donot believe that the 192,000 increase in non-farm payrolls registered in February will be a launching point forrapid employment growth. Accordingly,
we would not be surprised to see additional attempts to stimulate employmentgrowth from the White House, consequently. The economic impact will depend, obviously, on the merits of the policy.Suggestions for increased spending, or additional spending to help out state and local governments, will lead to greatereconomic turbulence, while fundamental tax reforms or effective deregulations could foster increased economic growth.
Figure 5
Presidential Approval Rating vs. Unemployment Rate
(approval rating frequency varies, unemployment rate monthly)
Source: BLSSource: Gallup

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