Friday, November 12, 2010

Laffer’s Wedge Model of Falling Employment

Having read the latest supply-side silliness from Art Laffer, I think we should ask Stanford University how they ever gave a Ph.D. in economics to him. Consider in turn three portions of this atrocious writing:

Since its cyclical zenith in December 2007, U.S. economic production has been on its worst trajectory since the Great Depression. Massive stimulus spending and unprecedented monetary easing haven't helped, and yet the Obama administration and the Federal Reserve still cling to the book of Keynes. It's an approach ill-suited to solving the growth problem that the United States has today.


We are in the midst of the Great Recession and Mr. Laffer thinks we have too much fiscal and monetary stimulus? I guess we are witnessing hyperinflation and high interest rates in his little Alice-in-Wonderland Economy (I had to give a hat tip to Jay Bookman somewhere). And there is:

The solution can be found in the price theory section of any economics textbook. It's basic supply and demand. Employment is low because the incentives for workers to work are too small, and the incentives not to work too high. Workers' net wages are down, so the supply of labor is limited. Meanwhile, demand for labor is also down since employers consider the costs of employing new workers—wages, health care and more—to be greater today than the benefits.


The reduction in employment is because folks are voluntarily leaving their jobs? There isn’t much of an unemployment problem? If Laffer really believes this – he might write that there was a movement along the supply curve rather than say “the supply is limited”. After all, the distinction between movement along a curve versus shift of a curve is found in almost every beginning textbook given to college freshman. Or was this a shift of the demand for labor schedule? Laffer’s writing is incredibly confused.

Actually what Mr. Laffer is suggesting is that there has been an increase in the wedge often modeled as the tax rate on employment:

Firms choose whether to hire based on the total cost of employing workers, including all federal, state and local income taxes; all payroll, sales and property taxes; regulatory costs; record-keeping costs; the costs of maintaining health and safety standards; and the costs of insurance for health care, class action lawsuits, and workers compensation … The problem is that the government has driven a massive wedge between the wages paid by firms and the wages received by workers.

Fine but this wedge has not been increased dramatically. Laffer does not even try to suggest that it has increased. All he is claiming is that a wedge exists. But it existed back in 2006 when the labor market was healthy. I guess his Stanford professors did not require this student to understand the concept of comparative statics!

If Laffer’s wedge model were the driving force behind firms reducing employment, one might seen this in terms of a dramatic increase in the Employment Cost Index but it seems the goods folks over at the Bureau of Labor Statistics provide little evidence to buttress Mr. Laffer’s absurd rant.

8 comments:

Lee said...

The trouble with Laffer, supply side economics, the Austrian school, etc. is that they aren't burdened with the scientific method of proving their theories. David Stockman explained it best in his famous Atlantic Monthly article, that supply side economics is a "trojan horse to bring down the top rate" of taxation on the wealthy.

Sandwichman said...

And, unless I'm mistaken, the implication of Laffer's highest priority job-creating measure is that it is the WEALTHY who make up the bulk of those voluntarily unemployed workers. Who knew the 9.6% unemployment rate was all those rich folks going Galt?

yorksranter said...

Employment is low because the incentives for workers to work are too small, and the incentives not to work too high. Workers' net wages are down, so the supply of labor is limited. Meanwhile, demand for labor is also down since employers consider the costs of employing new workers—wages, health care and more—to be greater today than the benefits.

So he thinks wages are both too low and too high at once.

Bill said...

It's the Goldilocks theory of economics, yorksranter

TheTrucker said...

The primary portion of the wedge is wage taxes and health care expenses. The removal/reduction of health care expenses from the payroll would seem to be a reduction in the wedge. So why is Medicare Buy In not happening. I am not referring to tax subsidized Medicare. I am talking about _ALLOWING_ people (and maybe even employers) to do business with the Medicare insurance provider just like they buy medical insurance from any other insurance company.

We all know why this will not be allowed. It is because the private insurance providers could never compete with a TRUE non profit insurance provider that did not provide Leer Jets to its management. The morons could still buy insurance from the private hijackers if they wanted, but why are the rest of us being forced to do so?

What happens to Medicare Buy In is that the moonbats jump on it and want to make it into a single payer tax supported system and the Republicans are smart enough to go along with them long enough to get them hooked, Then it is all government taking our freedoms away and the taxes will kill the world. But the moonbats never learn. They fall for it every time. There ain't no free lunch.

Don Levit said...

Trucker:
You are correct about true non-profits.
Blue Cross lost its tax exempt status in 1986, for it had evolved into its for-profit competitors.
In 1986, 501(m) was added to the Internal Revenue Code stripping Blue Cross (and similar insurers) of their tax-exempt privileges.
Why have any tax advantages if you are unable to distinguish your self from your for-profit competitors.
Since 1986, not one insurer, to my knowledgem, has taken adsvantage of 501(m) to truly set themselves apart from the pack.
Not one insurer has offered medical products which could be a win-win for the long term, for both insurer and insured.
Don Levit

Don Levit said...

I can provide links from the IRS to back up my points, if anyone is interested.
There ain't no free lunch, but there are better places to eat.
Don Levit

Jack said...

I haven't researched an answer so I'll only note that I think that GHI had also morphed into a for profit health insurer after years of being a highly regarded not for profit health insurer. The reason/excuse, as I recall the press reporting, was that as a for profit health insurer GHI (and it's new partner HIP) would be better able to raise money through borrowing. It didn't make any sense to me then nor still.