Congressional Budget Office
Director's Blog

The unemployment rate averaged 9.3 percent in 2009, more than double what it was in 2007 and the highest it had been since 1983. In 2009, nearly one in four people (including children) lived in a family in which at least one family member was unemployed at some time during the year. Among people living in a family with income below the poverty threshold, one in three lived in a family in which at least one person was unemployed at some point.

The unemployment insurance (UI) program provides a weekly benefit to qualified workers who lose their job and are actively seeking work. The amount of that benefit is based in part on a worker’s past earnings. The composition of the worker’s family and the income of the family as a whole are not generally taken into account. Nevertheless, the worker’s whole family is likely to be affected both by the spell of unemployment itself and by the support that the UI benefit provides.

Outlays for UI benefits totaled $120 billion in fiscal year 2009, a substantial increase over the amount two years earlier, which was $33 billion. Spending on UI benefits in fiscal year 2010 was even higher than in fiscal year 2009, totaling nearly $160 billion, and CBO projects that under current law, such spending in fiscal year 2011 will be $93 billion. (Under current law, federally funded extensions of benefits will begin to phase out on December 1, 2010.)

CBO examined the role of UI benefits in supporting the income of families in which at least one person was unemployed at some point in 2009. The analysis addressed how that role varied with the amount of family income and the number of weeks of unemployment for all family members. CBO also examined how the poverty rate and related indicators of financial hardship would have differed in the absence of the UI program. Although CBO’s calculations are based on data about individual people, the results are presented in terms of families, both to focus on the effects on families and for ease of exposition.

The major findings are:

• Almost half of families in which at least one person was unemployed received income from UI in 2009. In 2009, the median contribution of UI benefits to the income of families that received those benefits was $6,000, accounting for 11 percent of their family income that year.
• Both the percentage of families receiving UI benefits and the median annual benefits received by those families over the course of the year were larger for families with more weeks of unemployment than for families with fewer weeks of unemployment.
• In 2009, about 14 percent of families had income below the federal poverty threshold; those families received about 8 percent of total UI benefits paid out during the year. In contrast, 67 percent of families in 2009 had income more than twice the poverty threshold; those families received about 70 percent of total UI benefits. The higher-income families received a larger share of benefits for several reasons: because only people with sufficient recent work histories qualify for benefits, benefit levels rise with previous earnings, and receiving benefits tends to push families into higher income groups.
• Without the financial support provided to families by UI benefits (and under an assumption of no change in employment or other sources of income associated with the absence of that support), the poverty rate and related indicators of financial hardship would have been higher in 2009 than they actually were. For instance, in 2009 the poverty rate was 14.3 percent, whereas without UI benefits and under the assumption mentioned, it would have been 15.4 percent.

In assessing the role of UI benefits in supporting family income in 2009, CBO accounted only for people who received those benefits, the amount of benefits they received, and the other income they and their families received. CBO did not consider any changes in employment or other sources of income that might have occurred if those benefits were not available; a more-complete analysis of the effects of UI benefits on family income would incorporate such behavioral responses.

This analysis was prepared by Gregory Acs and Molly Dahl of CBO’s Health and Human Resources Division.

I am honored to be speaking today to “Town Hall Los Angeles,” which has been providing a public forum for discussion of important issues since 1937. My remarks highlight aspects of my testimony to the Senate Budget Committee a few weeks ago. (Sorry, Town Hall LA does not use slides, so there is nothing to accompany this summary.)

CBO and most private forecasters expect that the economic recovery will proceed at a modest pace during the next few years. In the forecast that we completed this summer, the unemployment rate remains above 8 percent until 2012. Two key factors influence that forecast. First, international experience suggests that recoveries from recessions that were spurred by financial crises tend to be slower than average. Following such a crisis, it takes time for consumers to rebuild their wealth, for financial institutions to restore their capital bases, and for nonfinancial firms to regain the confidence required to invest in new plant and equipment; all of those forces tend to restrain spending. Second, our projection is conditioned on current law, under which both the waning of fiscal stimulus and the scheduled increases in taxes (resulting from the expiration of previous tax cuts) will temporarily subtract from growth, especially in 2011.

Weak economic growth has serious social consequences. About 9½ percent of the labor force is officially unemployed, but many other people are underemployed or have become discouraged and left the labor force. The increase in unemployment is not uniform across demographic groups or regions; rather, the unemployment rate has risen disproportionately for less-educated workers, for men, and for people living in certain states. Moreover, the incidence of unemployment lasting longer than 26 weeks has been the highest by far in the past 60 years. CBO published an issue brief in April about the personal consequences of job losses.

Policymakers cannot reverse all of the effects of the housing and credit boom, the subsequent bust and financial crisis, and the deep recession. However, in CBO’s judgment, there are both monetary and fiscal policy options that, if applied at a sufficient scale, would increase output and employment during the next few years. In a report last January, we analyzed a diverse set of temporary policies and reported their two-year effects on the economy per dollar of budgetary cost, what one might call the “bang for the buck.” The overall effects of those policies would depend also on the scale at which they were implemented; making a significant difference in an economy with an annual output of nearly $15 trillion would involve a considerable budgetary cost.

In brief, CBO found the following: A temporary increase in aid to the unemployed would have the largest effect on the economy per dollar of budgetary cost. A temporary reduction in payroll taxes paid by employers would also have a large bang-for-the-buck, as it would both increase demand for goods and services and provide a direct incentive for additional hiring; this approach also could be scaled to a significant magnitude. Temporary expensing of business investments and providing aid to states would have smaller effects, and yet smaller effects would arise from a temporary increase in government spending on infrastructure or a temporary across-the-board reduction in income taxes.

However, there would be a price to pay for fiscal stimulus: Those same fiscal policy options would increase federal debt, which is already larger relative to the size of the economy than it has been in more than 50 years—and is headed higher. If policymakers wanted to achieve both stimulus and sustainability, a combination of policies would be required: changes in taxes and spending that would widen the deficit now but reduce it relative to baseline projections after a few years.

To illustrate this point, we analyzed both the short-term and longer-term effects of various options for extending the 2001 and 2003 tax cuts, extending higher exemption amounts for the AMT, and reinstating the estate tax as it stood in 2009 (adjusted for inflation). As I reported in the recent testimony, permanently or temporarily extending all or part of the expiring income tax cuts would boost income and employment in the next few years relative to what would occur under current law. That would occur because, all else being equal, lower tax payments increase demand for goods and services and thereby boost economic activity. That increase in demand is crucial because we think that economic growth in the near term will be restrained by a shortfall in demand. A permanent extension of the tax cuts would provide a larger boost to income and employment in the next two years than would a temporary extension. In addition, an extension of all of the provisions would provide a larger boost than would an extension of all provisions except those applying only to high-income taxpayers.

But the effects of extending those tax cuts on the economy in the longer term would be very different from their effects during the next two years. The longer-term effects would be the net result of two competing forces: All else being equal, lower tax revenues increase budget deficits and thereby government borrowing, which reduces economic growth by crowding out investment. At the same time, lower tax rates boost growth by increasing people’s saving and work effort. Those effects on the supply of labor and capital are crucial because we think that economic growth over that longer horizon will be restrained by supply factors. For some of the options, our estimates of the net effect of these forces based on different models and assumptions span a broad range. But the averages of the estimates across different models and assumptions indicate that all four of the options we analyzed—permanently or temporarily extending all or part of the expiring income tax cuts—would probably reduce national income in 2020 relative to what would otherwise occur. Beyond 2020, the reductions in income from all four of the policy options would become larger—especially for the permanent extensions.

Similarly, permanent large increases in spending that were not accompanied by reductions in other spending or tax increases would also put federal debt on an unsustainable path. For example, if discretionary appropriations apart from those for operations in Iraq and Afghanistan increased at the rate of growth of nominal GDP, rather than increasing just with inflation as assumed in our baseline, debt held by the public would reach nearly 80 percent of GDP by 2020.

I testified this morning to the Senate Budget Committee about the economic outlook and CBO’s analysis of the potential impact on the economy of various fiscal policy options. You can read a summary of my testimony (the full version, which is rather long, is also available), or you can glance at the slides I used, which are below.

Policymakers cannot reverse all of the effects of the housing and credit boom, the subsequent bust and financial crisis, and the deep recession. However, in CBO’s judgment, there are both monetary and fiscal policy options that, if applied at a sufficient scale, would increase output and employment during the next few years. But there would be a price to pay: Those same fiscal policy options would increase federal debt, which is already larger relative to the size of the economy than it has been in more than 50 years—and is headed higher. If policymakers wanted to achieve both stimulus and sustainability, a combination of policies would be required: changes in taxes and spending that would widen the deficit now but reduce it relative to baseline projections after a few years.

To assist policymakers in their decisions, CBO has quantified the effects of some alternative fiscal policy options. In a report last January, we analyzed a diverse set of temporary policies and reported their two-year effects on the economy per dollar of budgetary cost, what one might call the “bang for the buck.” The overall effects of those policies would depend also on the scale at which they were implemented; making a significant difference in an economy with an annual output of nearly $15 trillion would involve a considerable budgetary cost.

In brief, CBO found the following: A temporary increase in aid to the unemployed would have the largest effect on the economy per dollar of budgetary cost. A temporary reduction in payroll taxes paid by employers would also have a large bang-for-the-buck, as it would both increase demand for goods and services and provide a direct incentive for additional hiring. Temporary expensing of business investment and providing aid to states would have smaller effects, and yet smaller effects would arise from a temporary increase in infrastructure investment and a temporary across-the-board reduction in income taxes.

Today’s testimony went on to address the effects of another set of fiscal policy options. At the request of the Chairman of the Senate Budget Committee, we have now estimated the short-term and longer-term effects of extending the 2001 and 2003 tax cuts, extending higher exemption amounts for the alternative minimum tax, and reinstating the estate tax as it stood in 2009 (adjusted for inflation). The methodology for this analysis was quite similar to the methodology that CBO follows in analyzing the President’s budget each spring; we used several different models and made different assumptions about people’s behavior.

We examined four alternative approaches to extending the tax cuts: a “full permanent extension” that would extend all of the provisions permanently; a “partial permanent extension” that would extend permanently all of the provisions except those applying only to high-income taxpayers; a “full extension through 2012” that would extend all provisions but only through 2012; and a “partial extension through 2012” that would extend through 2012 all provisions except those applying only to high-income taxpayers. As shown in the following figure, all four of the options would raise national income, output, and employment during the next two years, relative to what would occur under current law. That would occur because, all else being equal, lower tax payments increase demand for goods and services and thereby boost economic activity.

Ranges of Effects of Four Tax Policy Options on Real GNP in 2011 and 2012

But the effects of those policy options on the economy in the longer term would be very different from their effects during the next two years. The averages of the estimates across different models and assumptions indicate that all four of the options would probably reduce income relative to what would otherwise occur in 2020 (see the figure below). Those effects are largely the net result of two competing forces: All else being equal, lower tax revenues increase budget deficits and thereby government borrowing, which reduces economic growth by crowding out investment. At the same time, lower tax rates boost growth by increasing people’s saving and work effort.

Effects of Four Tax Policy Options on Real GNP in 2020

Beyond 2020, and again relative to what would occur under current law, the reductions in income from all four of the policy options would become larger. Either a full or a partial extension of the tax cuts through 2012 would reduce income by much less than would a full or partial permanent extension.

In sum, and as CBO has reported before: Permanently or temporarily extending all or part of the expiring income tax cuts would boost income and employment in the next few years relative to what would occur under current law. However, even a temporary extension would add to federal debt and reduce future income if it was not accompanied by other changes in policy. A permanent extension of all of those tax cuts without future increases in taxes or reductions in federal spending would roughly double the projected budget deficit in 2020; a permanent extension of those cuts except for certain provisions that would apply only to high-income taxpayers would increase the budget deficit by roughly three-quarters to four-fifths as much. As a result, if policymakers then wanted to balance the budget in 2020, the required increases in taxes or reductions in spending would amount to a substantial share of the budget—and without significant changes of that sort, federal debt would be on an unsustainable path that would ultimately reduce national income. Similarly, even temporary increases in government spending would add to federal debt and reduce future income, and permanent large increases in spending that were not accompanied by other spending reductions or tax increases would put federal debt on an unsustainable path. Compared with the options examined here for extending the expiring tax cuts, various other options for temporarily reducing taxes or increasing government spending would provide a bigger boost to the economy per dollar of cost to the federal government.

CBO and the staff of the Joint Committee on Taxation (JCT) have prepared an estimate of the budgetary effects of H.R. 4213, the American Jobs and Closing Tax Loopholes Act, as posted on the Web site of the Committee on Ways and Means on May 20, 2010. CBO and JCT estimate that the legislation would increase budget deficits by about $123 billion for fiscal years 2010 and 2011, by about $141 billion over the 2010-2015 period, and by about $134 billion over the 2010-2020 period.

The legislation would reduce federal revenues by about $23 billion in 2010 and 2011, but would lead to a net increase in revenues totaling about $40 billion over the 2010-2020 period. The revenue effects are the net result of provisions that both increase and decrease revenues. Revenue reductions would result mainly from the extension for one year of various tax provisions that expired at the end of 2009, including the tax credit for research and experimentation expenses, and the 15-year straight-line cost recovery method allowed for specified leasehold, restaurant, and retail improvements. Revenue increases would result from a number of provisions including taxing so-called “carried interest,” altering various rules that corporations use to calculate their foreign tax credits and foreign-source income, and modifying the employment tax treatment of income earned by individuals in professional service businesses.

The legislation would increase outlays by $174 billion over the 2010-2020 period, mostly between 2010 and 2015. The bill would extend benefits under the unemployment insurance program, at a total cost of about $47 billion, and it would extend (for an additional six months) the increase in the federal share of Medicaid costs that was originally enacted in the American Recovery and Reinvestment Act of 2009, at a cost of about $24 billion. The legislation would also amend the system for payments to physicians under Medicare, at an estimated cost of $63 billion over the 2010-2020 period.

Under the new system for Medicare payments to physicians, payment rates would increase by 1.3 percent on June 1, 2010, and by another 1.0 percent on January 1, 2011; under current law, those payment rates would fall by about 21 percent on June 1 and by another 6 percent on January 1, 2011. During 2012 and 2013, a new formula would increase or freeze payment rates to physicians depending on the type of service performed and on whether they participate in a new practice arrangement established by the Patient Protection and Affordable Care Act passed earlier this year. Payment rates would be reduced by about 35 percent in 2014 to approximately the levels they would have been without the changes made between 2010 and 2013. For years after 2014, CBO estimates that payment rates would decline by an average of about 2 percent per year, keeping spending close to the amounts expected under current law in those years.
 

Each year, even when the economy is growing, millions of people lose a job for reasons other than poor performance or misconduct. In an issue brief released today, CBO reviews the research on the short- and long-term effects of involuntary job loss for reasons other than poor performance or misconduct on people’s future employment and earnings. In light of the recession that began in December 2007 and CBO’s projection that, under current law, the unemployment rate will remain elevated for a number of years, the brief focuses on the effects of involuntary job loss during periods of weak economic activity. The brief also summarizes some of the government programs that help people who have lost their job.

Many people who lose a job involuntarily find a new job, some quite quickly (within a month or so) and others after more time. For example, among people who were displaced from their job in 2003—when the unemployment rate peaked at 6 percent—and were reemployed by January 2006, CBO found that 10 percent were reemployed within a week. Another 25 percent found a job within a month. In contrast, 25 percent were jobless (although not necessarily searching for work) for six months or more.

In late 2009, about 4 percent of the labor force consisted of unemployed people who had been out of work for 27 weeks or more—well above the previous peak, which occurred after the back-to-back recessions of the early 1980s, and a substantial fraction of all of those who were unemployed. A shift away from temporary layoffs and toward permanent layoffs has contributed to the increased duration of unemployment in recent decades.

Further, finding a job may require substantial effort and flexibility, especially when openings are scarce, and the need to shift from one industry or occupation to another to gain a new job is partly responsible for workers’ prolonged unemployment. One analysis of data from 1978 to 1990 found that in some states with high rates of unemployment, that rate decreased only when many of the unemployed people moved to a different state. Now, when many homeowners owe more on their mortgage than their house is worth, many people may not be able to make such moves.

Some people who lose a job involuntarily do not find a new job. Some of those people may decide not to look for a new job, while others may look for a job but be unsuccessful in their search. Among those who lost a job involuntarily between 1981 and 2003, three groups of workers—women, older people, and less-educated people—were more likely to leave the labor force than were others who lost a job.

In both the short and the long term, people who lose a job for reasons other than poor performance or misconduct and then find a new job see their earnings decline, on average. Short-term declines in earnings—those in the first few years after a job loss—tend to be larger for people who lose a job during or shortly after a recession. For example, those who lost jobs from 2001 through 2003 experienced a 14 percent decline in earnings. The average decline in earnings associated with a job loss in periods of stronger economic activity between 1984 and 2000 was smaller.

For people who have acquired a substantial amount of firm-specific knowledge, the loss of a job can be associated with a relatively large decline in earnings in both the short term and the long term. Among men who lost their jobs in a mass layoff during the 1982 recession, older workers (those ages 50 to 55) experienced earnings declines in the year following their job loss that were more than 40 percent higher than the earnings declines of men in their 20s and 30s. Initial declines in earnings associated with losing a job during a recession may persist for many years. The new job might have both lower earnings and less potential for earnings growth in the future than the lost job. Among the men who lost their job in a mass layoff during the 1982 recession, earnings 15 to 20 years later were about 20 percent lower than those of similar men who did not lose their job.

A number of government programs are available to help people who have lost their job, such as unemployment insurance (UI) and the Supplemental Nutrition Assistance Program (formerly called the Food Stamp program). Disability Insurance and Supplemental Security Income are also available to some people who are unable to work because of a severe health problem. Training and education programs as well as provisions of the Consolidated Omnibus Budget Reconciliation Act of 1985 (known as “COBRA”)—which makes possible the continuation of health coverage at group rates for individuals—are also helpful to some people. Some of the programs are available only to people who have lost their job involuntarily and others are designed to help people, with or without jobs, who are experiencing misfortune (especially financial distress) for various reasons.

During the recent economic downturn, the federal government has expanded eligibility or increased the amount of benefits available through some of those programs, including the UI program. In fiscal year 2009, outlays for UI benefits totaled $119 billion. That represents a substantial increase over spending for UI in 2007, which totaled $33 billion.

This brief was prepared by Molly Dahl and Joyce Manchester of CBO’s Health and Human Resources Division.

I testified this morning before the Joint Economic Committee about policies to increase economic growth and employment in 2010 and 2011. This hearing was originally scheduled for several weeks ago but then canceled because of the snow. My prepared remarks today were essentially the same as those released a few weeks ago and were based on CBO’s January report on this topic and a follow-up letter to Senator Casey.

My comments emphasized three points:

First, although the economy is starting to recover from the most severe recession since the 1930s, CBO and most private forecasters expect a slow rebound in output and employment. In particular, CBO projects that the unemployment rate will average slightly above 10 percent in the first half of this year, fall below 8 percent only in 2012, and return to near its long-run sustainable level of 5 percent only in 2014. As a result, more of the pain of unemployment from this downturn lies ahead of us than behind us.

Second, fiscal policy actions, if properly designed, would promote economic growth and increase employment in 2010 and 2011. However, despite the potential economic benefits in the short run, such actions would add to the already large projected budget deficits. Unless offsetting actions were taken to reverse the accumulation of additional government debt, future incomes would tend to be lower than they otherwise would have been.

Third, different policies that have received public attention would have quite different effects on output and employment per dollar of lost tax revenue or additional government spending. To be sure, significant uncertainty attends any quantitative estimates of the effects of particular policies, and CBO has emphasized that uncertainty by reporting ranges of estimates that we believe encompass most economists’ views about the effects of each type of policy. Still, we think there would be significant differences in the cost-effectiveness of different policies (as measured in our analysis by years of full-time-equivalent employment per million dollars of total budgetary cost).

Policies that would have the largest effects on output and employment in 2010 and 2011 per dollar of budgetary cost would be those that could be implemented relatively quickly or targeted toward people whose consumption tends to be restricted by their income—for example, reducing payroll taxes for firms that increase payroll or boosting aid to the unemployed. The following figure summarizes the estimated effects of various policies on employment in 2010 and 2011.

Cumulative Effects of Policy Options on Employment in 2010 and 2011,
Range of Low to High Estimates

I was scheduled to testify a few days ago before the Joint Economic Committee about policies to increase economic growth and employment in 2010 and 2011. The hearing was canceled because of the snow, but we released my prepared remarks today. The testimony was based on CBO’s January report on Policies for Increasing Economic Growth and Employment in 2010 and 2011 and on CBO’s follow-up letter last week to Senator Casey, which provided additional information about options for reducing employers’ payroll taxes.

The testimony emphasizes three points:

First, although the economy is starting to recover from the most severe recession since the 1930s, CBO and most private forecasters expect a slow rebound in output and employment. Often, severe economic downturns sow the seeds of robust recoveries. During a slump in economic activity, consumers defer purchases, especially for housing and durable goods, and businesses postpone capital spending and try to cut inventories. Once demand in the economy picks up, spending by consumers and businesses can accelerate rapidly—which in turn generates demand for workers. CBO expects that the current recovery will be spurred by that dynamic, but in all likelihood the recovery will also be dampened by a number of factors. Those factors include the continuing fragility of some financial markets and institutions; declining support from fiscal and monetary policy; and limited increases in households’ spending because of slow income growth, lost wealth, and a large number of vacant houses.

Therefore, as shown in the following figure, CBO projects that the unemployment rate will average slightly above 10 percent in the first half of this year, fall below 8 percent only in 2012, and return to its long-run sustainable level of 5 percent only in 2014. As a result, more of the pain of unemployment from this downturn lies ahead of us than behind us.

Unemployment Rate (Percent)

Second, fiscal policy actions, if properly designed, would promote economic growth and increase employment in 2010 and 2011. However, despite the potential economic benefits in the short run, such actions would add to the already large projected budget deficits. Unless offsetting actions were taken to reverse the accumulation of additional government debt, future incomes would tend to be lower than they otherwise would have been.

Third, different policies that have received public attention would have quite different effects on output and employment per dollar of lost tax revenue or additional government spending. To be sure, significant uncertainty attends any quantitative estimates of the effects of particular policies, and CBO has emphasized that uncertainty by reporting ranges of estimates. Still, significant differences can be seen in the following figure, which shows the cumulative effect of a variety of different policy options on employment in 2010 and 2011, measured in years of full-time-equivalent employment per million dollars of total budgetary cost.

The largest effects on employment this year and next would probably arise from increasing aid to the unemployed, reducing employers’ payroll taxes in general, and reducing employers’ payroll taxes for firms that increase their payroll. Somewhat smaller effects would probably be produced by reducing employees’ payroll taxes, providing an additional one-time Social Security payment, allowing full or partial expensing of investment costs, investing in infrastructure, providing aid to states for purposes other than infrastructure, and providing additional refundable tax credits for lower- and middle-income households in 2011. Still smaller effects would probably be generated by extending higher exemption amounts for the AMT in 2010 or reducing income taxes in 2011.

Cumulative Effects of Policy Options on Employment in 2010 and 2011,
Range of Low to High Estimates

Much of CBO’s extensive analysis and writing on this topic in the past few months has been done by Janet Holtzblatt, Mark Lasky, Ben Page, and Susan Yang.

Last week I had the opportunity to speak at Morehouse College in Atlanta, Georgia. David Poyer, an associate professor in the economics department at Morehouse, spent last summer working at CBO, and he asked if I would be interested in coming down to Morehouse sometime. I told him that I would be delighted to come, and I was pleased to receive an official invitation from Morehouse president Robert Franklin.

I spoke to Morehouse students about CBO’s recent Budget and Economic Outlook: Fiscal Years 2010 to 2020. My slides highlighted:

• The slow and protracted recovery that CBO expects for the U.S. economy and labor market, including the likely effects in the next few years of the unusually large jump in the share of unemployed workers whose previous jobs have been permanently lost and the unusually sharp drop in people’s participation in the labor force as workers became discouraged from looking for a job.
• The notable deficits that CBO projects under current law, the significantly larger deficits that CBO projects under some policy alternatives that have received a good deal of attention (including extending the 2001 and 2003 tax cuts, indexing the alternative minimum tax to inflation, and increasing discretionary spending faster than price increases alone), and the sources of those deficits relative to past budget outcomes.

After my prepared remarks, four students joined me on stage and asked challenging questions about the future of health care reform, how to address the budget deficit, and other current issues. I then had a chance to talk with them and other students informally, wrapping up a very enjoyable visit.

Today CBO released a letter to Senator Robert Casey, Jr., in response to questions he asked about policies that could be adopted to increase employment.  Specifically, Senator Casey was interested in a policy option to reduce employers’ payroll taxes for firms that increase their payroll, and how different design elements of this type of policy might affect its impact on employment.

In CBO’s January 2010 publication, Policies for Increasing Economic Growth and Employment in 2010 and 2011, the agency analyzed the effects on employment of several policy options, including giving employers a one-year, nonrefundable credit against their payroll tax liability for increasing their payrolls in 2010 from their 2009 levels. (To finance Social Security, employers and employees each pay 6.2 percent of an employee’s annual earnings up to a maximum.) Such a tax cut would lead to increased employment through a number of channels. For example, some firms would hire more people because hiring would be less expensive; others would lower prices to increase sales, thus spurring production and increasing the demand for labor; still others would increase compensation for employees, which would encourage more spending.

CBO measured the effect of that policy (and others) on employment as the cumulative effect on years of full-time-equivalent employment for each dollar of a policy’s total budgetary cost.  (A year of full-time-equivalent employment is 40 hours of employment per week for one year.) CBO estimated that, through its effects on wages, prices, and profits, the policy would add 8 to 18 cumulative years of full-time-equivalent employment in 2010 and 2011 per million dollars of total budgetary cost, measured in terms of lost revenues. Thus, the budgetary cost of increasing employment by one full-time person for one year would probably be between $56,000 and $125,000. Although such a policy would have economic benefits in the short run, it would also add to already large projected budget deficits. Unless offsetting actions were taken to reverse the accumulation of additional government debt, future incomes would tend to be lower than they otherwise would have been.

Policymakers could structure legislation that reduced payroll taxes for firms that increase employment using various combinations of caps on the total amount of the tax benefit a firm could receive, limits on the size of firms that would receive the tax cut, methods of measuring payroll growth, and other elements. In today’s letter, CBO separately analyzed several key policy design elements and concluded that, per dollar of budgetary cost:

• Capping the size of the tax cut for individual firms would decrease the employment effect; 
• Restricting eligibility to small firms would decrease the employment effect; 
• Limiting the eligible wage base would not change the employment effect, but would alter the types of employment fostered by the policy; 
• Basing the tax cuts on the total payroll in 2010 for new hires rather than on the net change in a firm’s payroll from 2009 to 2010 would have a similar effect on employment; 
• Offering larger tax cuts in economically depressed areas would probably not significantly alter the effect on employment; 
• Raising awareness of the tax change would increase the employment effect; and 
• Increasing the complexity of the tax change would reduce the employment effect. 

Understanding how the annual earnings of workers have changed over time is integral to projecting possible changes in such earnings in the future and considering government tax and spending policies that affect workers.  Last week CBO released a paper documenting changes in workers’ annual earnings during the past three decades.

The paper first describes changes between 1979 and 2007 in the annual (inflation-adjusted) earnings of workers ages 25 to 54. CBO found, as depicted in the figures below, that men with relatively low, median, and relatively high earnings (specifically, men at the 10th, 50th, and 90th percentiles of their earnings distribution) earned more than women in the same position of their own earnings distribution in 2007, and that those differences were smaller in 2007 than in 1979.

Real Annual Earnings at Selected Percentiles of Men’s and Women’s Earnings Distributions (Thousands of 2007 Dollars)

CBO also compared the differences in earnings between low, median, and high earners of the same sex in a given year. For men, the ratio of the earnings of high earners to those of median earners was larger in 2007 than in 1979, whereas the earnings ratio for median and low earners was roughly the same in the two years. For example, in 2007 men in the 90th percentile earned 2.4 times what men in the 50th percentile earned; that ratio was 1.8 in 1979. For women, in contrast, the ratio of the earnings of high earners to those of median earners was roughly the same in 2007 as it was in 1979, but the earnings ratio for median and low earners was smaller in 2007 than it was in 1979.

The paper also documents changes between 1989 and 2005 in the annual earnings of workers with very high earnings. CBO found that men with earnings at the top of their earnings distribution (those at the 95th and 99th percentiles) earned more than women at the top of their distribution in each year, although that difference declined over time. The earnings of men and women at the top of their earnings distributions were higher in 2005 than they were in 1989, and the increase for workers at the 99th percentile of the distribution was larger than for workers at the 95th percentile. Also, the share of earnings held by workers in the top 5 percent of the distribution increased between 1989 and 2005.

Additionally, CBO examined changes in earnings mobility and variability. Dividing the population into five groups based on earnings, CBO found that the fraction of people moving from one group to another (for example, from the bottom fifth of the distribution to the top fifth) over various five-year spans was roughly unchanged from 1989 to 2005 for both men and women. Slightly more than one-quarter of men and women experienced increases or decreases in earnings of 50 percent or more between 2004 and 2005. The percentage was similar for year-over-year changes throughout the 1989–2005 period.

This paper was prepared by Molly Dahl and Jon Schwabish of CBO’s Health and Human Resources Division.