Optimal tax policy for a Keynesian recession?

This paper offers recommendations for how the design of labor income taxes should change during recessions, based on a simple model of a recessionary economy in which jobs are rationed and some employees value working more than others do. The paper draws two counter-intuitive conclusions for maximizing social welfare. First, subsidize non-employment. This draws marginal workers out of the labor force, creating “space” for those who really need jobs. Second, subsidize employers for hiring, not the employees themselves. The problem during recessions is having too few jobs; subsidizing employers creates more jobs, while subsidizing employees confers benefits on those who already won the job lottery. Tax policy in the recent recession has done a poor job of following these recommendations.

Recommendations or reductios?  It still seems that extensions of unemployment insurance somewhat raised the rate of unemployment (if only by a small amount), contrary to many Keynesian predictions.  The implied multiplier in that data seems to be zero, as Garett Jones has pointed out.  And do hiring and wage subsidies still make sense, as opposed to job search subsidies, if unemployment follows from matching problems rather than traditional aggregate demand deficiencies?  Unclear, to say the least.

The paper is from Zachary D. Liscow and William A. Woolston, via the excellent Kevin Lewis.


Comments for this post are closed