A quarter of a century ago, the U.S. workforce was a wonder. Laid off in one corner of the economy, Americans quickly landed jobs elsewhere. But over the past decade, a profound change has come about. If U.S. leaders understood what was at stake, their fights on taxes and spending would assume a different character.
In 2000, according to data from the Organization for Economic Co-operation and Development, U.S. unemployment was the lowest in the G7 group of countries. Because jobs in America were easy to find, Americans felt confident in seeking them: the labor force participation rate was the G7’s highest. Combining these two effects, the share of U.S. 15-64 year-olds in work, at 74 percent, stood far above competitors. Within the G7, only the UK, with 72 percent, came close.
Fast forward to 2012. U.S. unemployment has gone from lowest in the G7 to third highest. Because workers have become discouraged, the U.S. labor force participation rate has slipped from the top spot to the middle of the pack. In consequence, the share of Americans in work has declined by fully 7 percentage points, a fall nearly three times more drastic than experienced in the UK. Meanwhile, in the other five G7 countries, the employment-to-population rate has actually risen.
This is not Ronald Reagan’s America - nor Bill Clinton’s, come to that. A once enviable labor market has consigned millions to material and psychological want. Nor is it simply the amount of joblessness that has exploded. Back in 2000, the U.S. could boast that just 6 percent of its unemployed workers had been out of a job for 12 months or more. But by 2011, that share had jumped to 31 per cent.
Why has the U.S. lost its advantage? The answer is bigger than the financial crisis. The U.S. employment rate began falling before then, sliding from 74 percent in 2000 to 72 per cent in 2006; besides, the UK experienced a similar financial bust without an equivalent employment setback. Rather, the truth is that U.S. labor market arrangements, which worked brilliantly for a generation, are no longer adequate.
The U.S. labor market formula has traditionally consisted of a stick and a carrot. Americans were barred from receiving unemployment insurance for more than 26 weeks, which pushed them to accept jobs even if they involved moving home or taking a pay cut. Meanwhile the government dangled a juicy negative income tax in front of low-income workers, boosting pay for those who re-entered the work force.
Limited welfare and low taxes combined to minimize the U.S. “participation tax rate”. Take an American worker with two children who moved in 2009 from short-term unemployment into a job paying half the average wage; he could expect to be better off to the tune of 62 percent of his new earnings, according to the OECD. If that worker was exiting long-term unemployment, the reward for returning to work was even stronger. These sensible incentives stood in contrast to perverse incentives elsewhere. In Japan and Ireland, some unemployed people faced a participation tax rate of over 100 per cent. Taking a job would leave them worse off.
America’s low employment-tax wedge remains a huge strength. But it is no longer enough. Technological change has reduced opportunities for low-skilled men and a lousy school system has failed to equip them for this challenge. By 2005, fully a quarter of working-age U.S. men without a high-school diploma were out of the workforce. When the crash wiped out low-skilled construction jobs, that share leapt to 35 percent.
Faced with this cadre of hard-to-employ men, the U.S. has had to recognize that the old time limit on unemployment insurance is harsh and unhelpful. Starting in 2009, the limit has been extended; some workers have collected for as long as 99 weeks. Meanwhile the number of Americans receiving disability payments has shot up from 5m to almost 9m since 2000. Such benefits have no time limits.
If the labor market stick has cracked, the carrot is decaying. The key challenge is low-skilled men, many of whom are not married. But America’s negative income tax is overwhelmingly targeted at parents. The U.S. has spent a generation boosting incentives for high-skilled workers by cutting top marginal tax rates. But payroll taxes have been allowed to take a rising share of low earners’ incomes.
In an important recent paper, the IMF’s Fiscal Affairs Department surveys some ideas U.S. politicians might heed. Payroll taxes should be reduced, especially for low-income workers. Enrolment on disability should be policed for abuses, and the disabled should be encouraged to re-enter the workforce where possible. Unemployment insurance could be financed by individual accounts, strengthening workers’ incentive to return to work promptly. Shorn of effective time limits, insurance benefits should be tied to participation in training programs that push workers into jobs.
So far, none of these ideas has received serious attention from leaders. The politicians’ idea of a tax debate is a slanging match about top marginal rates, not an intelligent rethink of the payroll tax wedge. Their idea of a spending discussion is to bicker about whether discretionary outlays should be cut aggressively or downright savagely. The cramped terms of the debate help to explain why work training schemes in the U.S. have actually shrunk recently and are a pale shadow of the standard model in the rest of the rich world. As for the vital challenge of retooling U.S. education, neither candidate seems interested. The U.S. labor miracle may be left to die quietly. It deserves better.