Lessons on Job Creation for the 112th Congress

When the 112th Congress convenes in January, the first order of business should be to address what many Americans worry about more than health care, Afghanistan, or global warming—jobs.

Americans are rightly concerned. Although the National Bureau of Economic Research announced that the recovery ended in June 2009, the unemployment rate is still at 9.6 percent, meaning nearly 15 million Americans remain unemployed. Moreover, 42 percent of the unemployed have been out of work for six months or longer. As of this writing, since the end of the recession the economy has lost 439,000 jobs. This dismal picture comes despite almost a trillion dollars in stimulus programs.

Uncertainty about potential future tax increases as well as increased costs of regulation, health care, and energy are raising the near-future costs of employment, thereby discouraging employers from hiring today. With global markets in labor and capital, businesses can expand overseas rather than in the United States—which they are doing. The American unemployment rate used to be low compared to Europe and Canada, but it is now the highest of all industrialized countries except France.

Until Congress changes course and makes the country a more attractive location for employment, unemployment rates will remain high. To this end, the 112th Congress should extend current tax rates, cut spending, reform the new health care law, and abandon plans for further costly regulation.

Will Taxes Increase in 2011?

Taxation is a prime example of the uncertainty facing employers. Congress has yet to decide whether or not it will let the Bush tax cuts expire at the end of this year. Small businesses to large multinationals are left in the dark regarding their tax rates come January and so are afraid to expand without knowledge of next year’s expenses.

If they file as a sole proprietorship or a partnership, will their tax rates be 10 or 15 percent at the low end, or 35 or 39.6 percent at the high end? For corporations, what about the taxes on dividends, if the company issues dividends? Will the rate be 15 percent, or will dividends be taxed at still-undetermined ordinary income levels? How about capital gains taxes? Will the long-term capital gains tax rate be 15, 20, or 25 percent?

Moreover, will businesses be able to take advantage of expensing of equipment and a permanent research and experimentation credit? That might help build capital and in some cases hire additional workers. But businesses don’t have that answer, and so they can’t plan.

It’s possible that Congress will limit tax increases to singles making over $200,000 and couples making over $250,000 of gross income (approximately $172,000 and $209,000 of taxable income, respectively). Even so, the effects of these tax increases will not be limited to those in the upper brackets. The government can’t tax the most productive people in the economy without creating negative consequences for the others.

This is because top income filers purchase goods and services. They own or manage businesses that employ other Americans. They have capital investments that fund businesses that create jobs. In addition, their tax revenues pay substantial shares of federal and state tax revenue that is distributed down the income chain through government benefits, such as food stamps and Medicaid. In 2007, the latest year with available information, the top one percent of tax filers earned 23 percent of adjusted gross income and paid 40 percent of federal income taxes.

Treasury data shows that 48 percent of small business income on individual returns accrues to unincorporated businesses making over $250,000 per year. If these businesses’ taxes rise, some will close or curtail expansion plans, thus shrinking their payrolls.

Lesson number one for Congress—avoid the January 1, 2011 tax hike.

Employers’ Health Care Headache

The new health reform bill will discourage hiring and result in lower take-home wages. In accordance with the new health care reform bill, a supplemental Medicare tax increase will take effect on January 1, 2011, and regulations on health insurance and the employer penalties and mandates will become fully effective on January 1, 2014.

Companies across the industry spectrum such as AT&T, Verizon, Prudential, and Caterpillar have taken write-downs on earnings in anticipation of the new bill raising their costs. Higher insurance premiums and taxes on income and payrolls will leave individuals with less to spend on goods and services, and businesses with less to spend on hiring workers.

The job-killing provisions of the law are numerous, especially among low-skilled workers.

In accordance with the new law, employers with 50 workers or more will be required to offer health care for employees, or pay a $2,000 fine per employee. For employers that do not now offer the prescribed set of health benefits, this new requirement increases their out-of-pocket expenses. As a result, workers are likely to receive lower wages (or to not receive a pay increase at the end of the year) to compensate for the companies’ higher costs.

In addition, since the penalties and costs affect firms with more than 50 workers, those with fewer than 50 workers will be discouraged from hiring more, and firms with slightly more than 50 workers, for example 55 to 60, will consider contracting-out certain services or shedding labor to get to that magic number delineated by Congress.

Beginning in 2011, all firms will have to file 1099 forms with the IRS if they buy more than $600 worth of goods from one supplier. That’s more than $600 in office supplies, document shredders, computers, or gasoline. Such paperwork will not only take time and money away from running a business but will encourage multinationals to locate new plants offshore.

The law also prescribes what constitutes a qualified benefit plan. Insurance companies will be required to cover everyone, regardless of preexisting conditions, with relatively low penalties for those who do not participate. This will lead many to purchase health insurance only when they get sick, forcing the insurance companies to increase the cost of health care insurance for everyone off the bat. In addition, the law prohibits co-payments for routine visits, such as annual check-ups and mammograms, and requires coverage for mental health and substance abuse, and dental care for children—again a reason for insurance companies to raise the price of being insured.

Requiring employers to offer expensive health insurance to all workers—or pay a penalty—discourages hiring. Just as employers do not offer home or auto insurance, they should not have to provide health insurance as a benefit. Alternatively, the government could give everyone a refundable tax credit, the amount varying by income, and allow them to choose a health insurance plan. This could be funded by taking the tax deduction from the employer and giving it to the individual. Representative Paul Ryan (R-WI) has suggested $2,300 per individual and $5,700 per family.

Lesson number two for Congress—don’t require employers to offer health insurance or other expensive benefits to their employees.

Energy Tax Uncertainty

A proposed tax on energy is creating uncertainty for energy-intensive industries. A cap-and-trade bill increasing federal spending by $846 billion and raising direct spending by $821 billion passed the House of Representatives in June in legislation sponsored by Democrats Henry Waxman of California and Ed Markey of Massachusetts. If the bill, or one like it, becomes law, greenhouse gases would be required to decline by 17 percent by 2020 and by more than 80 percent by 2050. This is breathtaking regulatory ambition—and dangerous for the American economy and workforce.

At a time of fragile employment growth, such proposals would worsen unemployment, both long- and short-term. American greenhouse gas emissions, chiefly carbon dioxide, would be required to decline on a per person basis to late 19th century levels. Businesses would be required to invest in energy efficiency and low-carbon or zero-carbon fuels, offset emissions through investments in agriculture and trees, and pour money into emission-offset activities abroad.

Even if increases in greenhouse gases contribute to global warming—of which there is no proof—unilateral emissions reduction by the U.S. without similar action by China and India would have a negligible effect on global warming. And with the revelation that scientists at the University of East Anglia in Britain destroyed original temperature data, the science of global warming is far from settled.

Allowances to emit greenhouse gases within the United States would be issued by the Environmental Protection Agency at a steadily declining rate through 2050. If emissions exceed a firm’s allowance, or cap, the company would have to buy additional allowances from the government or other firms. Such mandatory purchases is nothing more than a tax by another name and, like any tax, would drive up costs, which would be passed on to consumers, again reducing spending and employment.

Not only do such proposals penalize American firms through higher costs, they give firms a financial incentive to move abroad to acquire “offsets”—credits from activities that supposedly lower carbon emissions elsewhere. The offset provisions encourage firms to shift economic activity to countries with laxer emissions standards, further damaging U.S. job creation. A plant’s emissions might exceed its U.S. allowances, yet its technology might produce lower emissions than the norm in a developing country, allowing relocation abroad to count as an offset.

In Spain, economics professor Gabriel Calzada Alvarez of the Universidad Rey Juan Carlos has calculated that his country has spent €571,138 ($793,000 at today’s exchange rates) per green job. Higher energy costs have driven away jobs in metallurgy, mining, and food processing, so over two jobs have been destroyed for every one created. Even in Spain, solar power did not account for even one percent of 2008 electrical production.

If global warming is indeed a problem—and it currently polls low on Americans’ list of concerns, far behind jobs—it could be addressed in less expensive ways, such as injecting fine sulfur particles into the upper atmosphere to slow down the sun’s warming, or spraying clouds with salt water to make them reflect radiation away from earth. These approaches could be successful without other countries’ cooperation.

Lesson number three for Congress—increases in energy taxes reduce employment.

Minimum Wage Woes

Between 2007 and 2009, the federal minimum wage rose to $7.25 from the $5.15 rate that had prevailed throughout the previous decade.

Teens are paying the price of Congress’ generosity, with an unemployment rate of 26 percent. Over the past two years the overall unemployment rate has increased by almost four percentage points, to 9.6 percent from 5.6 percent, yet teenage unemployment has risen more than seven full percentage points, to 26 percent from 18.8 percent.

Teenagers are particularly vulnerable to minimum wage increases due to their relatively low levels of experience and job-learned skills.

David Neumark, professor of economics at the University of California (Irvine), and William Wascher, an economist at the Federal Reserve, reviewed over 100 studies on the effects of the minimum wage on employment in a 2007 paper entitled “Minimum Wages and Employment.” They conclude that “among the papers we view as providing the most credible evidence, almost all point to negative employment effects, both for the United States as well as for many other countries.”

Neumark and Wascher specifically mention teens and low-skilled workers. As they state, “Moreover, when researchers focus on the least-skilled groups most likely to be adversely affected by minimum wages, the evidence for disemployment effects seems especially strong.”

New Hampshire and Illinois have minimum wage laws that exceed the new federal one, so their residents were not affected by the federal wage increase. So do California and Massachusetts, homes to outgoing House Speaker Nancy Pelosi, House Education and Labor Committee Chairman George Miller, and the late Edward Kennedy, former chair of the Senate Health, Education, Labor and Pensions Committee, who led the charge for the higher federal minimum wage.

Yet the workforce in California, Massachusetts, and Illinois is declining, with residents migrating to fast-growing states without state minimum wage laws such as South Carolina and Alabama. Increasing the federal minimum wage is the latest in the blue state vs. red state battles, with the congressional leadership spreading the pain and reducing the growth of states with more sensible policies.

Minimum wage workers are overwhelmingly young, part-time, and work in the food service industries. Workers under the age of 25 make up half of the 2.2 million minimum wage workers. Employed teenagers are almost ten times more likely to be among the minimum wage earners than workers older than 25.

Members of Congress assumed that raising the minimum wage would not affect employment numbers. But this has not been the case. In fact, an increase to $7.25 an hour, plus the mandatory employer’s share of social security, unemployment insurance, and workers’ compensation taxes, brings the hourly employer cost close to $8 an hour, even without any benefits.

Although it sounds compassionate to alleviate poverty by mandating the minimum amount of money companies must pay out, employers won’t necessarily cooperate. Instead, they will only employ workers who can produce $8 an hour of goods or services: That means hiring fewer people, especially teenagers. Alternatively, employers can also change technologies or hire more skilled workers to keep their firms in business.

Denying work opportunities to those whose skills and output do not add up to $8 per hour is not compassionate—it is manifestly unfair. The federal government essentially would be mandating that workers below a given level of skill have no right to work.

Much of Europe keeps a quarter of its youth unemployed, not with minimum wages, but with generous benefit packages (also proposed by Congress) that discourage work. The predictable effect is high unemployment rates with a substantial percentage out of work for more than a year, leading to deteriorating skills and a permanent underclass. This is not a good route for America.

Most American employers have to pay more than minimum wage just to attract and hold the workers they need. Over 137 million employees now earn above minimum wage, not because of federal or state law, but because that is the only way that firms can attract and keep employees with skills.

Lesson number four for Congress—The higher the minimum wage, the more low-skilled Americans are priced out of jobs.

Conclusions for Congress

The 112th Congress should take a different route to job creation than its predecessor. A trillion dollars worth of stimulus has not produced job growth, and the U.S. labor force participation rate—the percentage of Americans who say they are either working or looking for work—is at 1985 levels. The rate of GDP growth is slowing, and even President Obama has admitted that shovel-ready projects do not exist.

Instead, Congress should keep taxes at current rates and trim federal spending. To encourage employers to hire, Congress should nix the law that requires employers to offer health benefits to workers, put aside the idea of an energy tax bill, and consider a blanket exemption for all teens from the minimum wage.

Unemployment is the most serious problem facing America today. If the new Members of Congress fail to solve it—or worse, if they take actions that increase unemployment rates—they might find themselves without jobs in 2013.