It's a Fact That Politicians Wreck Work Incentives

Despite gains in employment and a drop in the jobless rate in November, the labor force data released Friday were disturbing. They showed a drop of 350,000 in the number of people in the labor force, a big decline for one month and an extension of a troubling trend.

Here is the bigger picture: the proportion of working-age Americans who have jobs or who are looking for them has been falling, even though employment has been expanding, albeit fitfully and at a sluggish pace.

It is understandable that people drop out of the labor force-stop looking for work-when unemployment is rising and they have become discouraged. But, since the employment rebound from the 2007-2009 recession began in March 2010, the labor-force participation rate has fallen for both men and women. This appears to be part of a long decline that dates from 2000.

My belief is that one reason for this trend, which appears to be continuing, is the panoply of government benefits, including unemployment insurance, now available up to 63 or 73 weeks, depending on the state. Other elements of the federal safety net include food stamps, mortgage relief, and Temporary Assistance to Needy Families. The provision of subsidized health care for those earning below 400 percent of the poverty line under the Affordable Care Act, beginning in 2014, will exacerbate this.

This question of cause-and-effect is complicated. Fresh support for my view comes from a book by Casey B. Mulligan, an economics professor at the University of Chicago, published last month by Oxford University Press. Its title is: The Redistribution Recession: How Labor Market Distortions Contracted the Economy (Oxford University Press, 2012).

Mulligan has crunched a lot of numbers. They appear to show that benefits account for half the decline in the labor force participation rate. He examines how increases in benefits have discouraged people from working by raising marginal tax rates among recipients. As beneficiaries lose their eligibility for benefits by working, the loss of these benefits has the same effect as a tax.

These programs have expanded in two ways. Eligibility has increased, and the programs have become more generous.

Take unemployment insurance. It is particularly relevant both because it represents a large share of all benefits paid to individuals and because the extension of unemployment insurance benefits, beyond 26 weeks, the usual duration, will terminate if America goes off the fiscal cliff. That would end, in January, payments to 2.1 million people, and another million would lose benefits over the next quarter.

Between 2007 and 2010, when the country was in deep recession and gradual recovery, spending on unemployment insurance rose by 293 percent adjusted for inflation, Mulligan calculates. If unemployment eligibility and benefit rules had remained at 2007 levels, spending would have risen by 50 percent.

Mulligan explains that when unemployment insurance pays more, "the reward to working declines, because some of the money earned on the job is now available even when not working. Decades of empirical economic research show that the reward to working, as determined by the safety net and other factors, affects how many people work and how many hours they work."

Mulligan calculates that extending the duration of unemployment benefits alone account for about one-sixth of the shrinkage of hours worked. He estimates that all benefits taken together explain about half of the decline. The other half is explained by the recession and difficulty of finding a job.

In contrast, New York Times columnist Paul Krugman wrote on December 6 that in order to reduce unemployment "our still-depressed economy needs more fiscal stimulus."

Under the 2011 law that requires the January 1 cuts in spending and tax rate increases (unless Congress acts), a number of benefit programs are exempt or would be trimmed only slightly. Nevertheless, they could be modified if President Obama and the Republicans make a fiscal deal.

Such programs include food stamps, Supplemental Security Income, Medicaid, the Children's Health Insurance Program (CHIP), Temporary Assistance for Needy Families, and refundable tax credits like the Earned Income Tax Credit and the Child Tax Credit.

By returning these programs to 2007 levels, the unemployment rate would likely decline by eliminating disincentives for people to work.

What is troubling is that as the economy gradually improves, the labor force as a percent of the population is shrinking. With the population aging and a smaller share of younger workers, this trend will lead to steadily higher federal and state tax burdens on the young, even if Congress reduces taxes and modifies Social Security and Medicare benefits for future retirees. This is also a problem in Japan and Europe, where the ratio of the retired to the working is rising.

The commonsense conclusion that many federal programs discourage Americans from working is not ideology. It is the finding of careful empirical economists, including Professor Mulligan.