TaxProf Blog

Editor: Paul L. Caron, Dean
Pepperdine University School of Law

Friday, July 28, 2017

Weekly SSRN Tax Article Review And Roundup

This week, Orly Mazur (SMU) reviews a new work by Zachary Liscow (Yale Law School) and William Woolston (Stanford University, Department of Economics),  How Income Taxes Should Change During Recessions, Tax Law Review, Forthcoming.

Mazur (2017-2)Economic recessions, a frequent occurrence in our history, are destructive in many respects. They cause wide-spread unemployment, a decline in economic growth, sinking asset values, fear and uncertainty, among other economic and social costs. Although economists generally agree that increased government spending can spur economic growth during a recession and alleviate this burden, the current literature does not sufficiently address how to design the spending so that it maximizes social welfare during a recession.

In their recent article, Liscow and Woolston (hereinafter, “LW”) make an important contribution to the literature by recommending two ways to improve fiscal policy design during a recession in the context of labor income taxes and related policies. Specifically, LW propose that Congress should (i) increase effective subsidies on the non-employed and (ii) subsidize employers rather than employees during recessions.

LW base these policy recommendations upon a novel model of the recessionary economy. Drawing upon the microeconomics literature on how labor markets function during recessions, LW conclude that jobs are rationed during recessions and that such rationing is inefficient. According to the authors, it is “this inefficient rationing, not the shortage of jobs per se, [that] is the much bigger cause of social welfare loss in the economy.” Identifying these key features of a downturn economy has important implications for policy design. First, the policies that LW recommend address how to fix these issues. In particular, by seeking to create more jobs and ensure that the right workers are in existing jobs, LW’s recommendations would likely maximize social welfare with respect to labor markets during recessions. Second, these features of a recessionary economy suggest that with high unemployment, statutory incidence can be critical for policy effectiveness. Third, the authors’ conclusion that inefficient rationing is significant for economic recovery may provide a way to help address the poor political optics of their second recommendation.

Although these recommendations are perhaps counterintuitive, they are persuasive and based on sound evidence. According to the Congressional Budget Office (CBO), the criteria for evaluating the success of fiscal policy actions are timing, cost-effectiveness, consistency with long-term fiscal objectives, and other considerations. In this article, LW address the timing concerns by suggesting ways to implement their policies that would ensure that the economic effects of the fiscal stimulus occur during the period of economic weakness. LW also look to the effectiveness of the policies that Congress adopted during the Great Recession of 2008-2009 to demonstrate the cost-effectiveness of their recommendations relative to policies that focus on employee-sided subsidies. In particular, their recommendations appear in line with CBO’s conclusion that “policies that would have the largest effects on output and employment per dollar of budgetary cost are ones that would reduce marginal cost to businesses of adding employees or that would be targeted toward people who would be most likely to spend the additional income.” LW’s work also considers who would be helped most by the policies being considered. However, as the authors’ acknowledge, much work remains to be done in determining how to design the best policy response to counteract these features of a slack labor market. Such future work should hopefully also include a discussion of how these fiscal policies can be designed to be consistent with long-term fiscal objectives, protect the labor market efficiency in the long-run and minimize any negative effects on long-term growth.

In sum, this work raises novel and significant implications for fiscal policy design during a recession. As we continue to evaluate what fiscal policies worked and what did not during the recent recession, LW’s work provides a new perspective on why the government response fell short in the context of labor income tax policy and how to improve tax policy the next time around. 

Here’s the rest of this week’s SSRN Tax Roundup:

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