The Brass Tack

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Posts Tagged ‘Krugman’

Yup, it’ll cost jobs.

Posted by srconstantin on July 18, 2009

I’m sorry if lately it’s been all health care, all the time — it’s the news of the hour, and I’m learning as I go.
The new plan in the House pays for healthcare with a surtax on wealthy families and a payroll tax on companies that do not provide health insurance.

That’s a problem. Now I’m not one of those who thinks taxing the rich is bad in itself; it’s the payroll tax that is problematic. It’s a retrenchment, instead of the promised reversal, of the subsidy for employer-provided insurance, which leads to high rates of medical bankruptcy.

And there’s no way to argue that raising payroll taxes won’t cost jobs. If you believe in wage rigidity at all, then making the marginal worker more expensive will make companies less likely to hire him. Arnold Kling and Paul Krugman have been batting this back and forth for a while, but I think there’s no escape from it. Krugman (who knows Keynes backwards and forwards, which I can’t say of myself) argues that under Depression conditions, with short-term interest rates near zero, lowering wages shouldn’t increase employment.

“Suppose that wages across the US economy had been, say, 20 percent lower than they actually were. You might be tempted to say that this would make hiring workers more attractive. But to a first approximation, prices would also have been 20 percent lower — so the real wage would not have been reduced. So how would lower wages lead to higher demand for labor?
Well, the real money supply would have been larger — but the normal channel through which this might increase demand, lower interest rates, was blocked by the zero lower bound. ”

But let’s think about this for a moment. Suppose you raise payroll taxes. Let’s say that increases prices, and so contracts the money supply, in a mirror image of Krugman’s argument. But it is possible to raise interest rates if they’re starting at zero, so it’s not clear why this shows that demand for labor won’t drop. Please, correct me if I’m missing something — I’m pretty sure it’s more likely to be ignorance on my part than stupidity on Krugman’s.

He’s not the only one to think this: Gauti Eggertsson thinks that raising payroll taxes would increase the costs of doing business for firms, and drive the AS curve upward and inward, forcing businesses to raise prices. This, he says, would reduce deflationary expectations and actually help end a recession. Again, I don’t understand what mechanism prevents firms from hiring fewer workers when the cost of labor rises.

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