Black and brown people—and especially Black women—regularly face discrimination in schools and the workplace based on the texture and style of their hair. This is yet another form of racial discrimination and yet another way to control and police Black and brown people.

Twenty-four states across the country have responded by passing the CROWN (“Creating a Respectful and Open World for Natural Hair”) Act,1 which prohibits hair-based discrimination at work and school. The movement to pass the CROWN Act is gaining momentum in states across the country, as well as at the federal level. The Act is about strengthening worker protections and ensuring dignity and respect for cultural expression.

The effects of hair-based discrimination

Hair can be a declaration of personal identity and serve as a symbol of heritage and ancestry. Many Black and brown people signify their cultural heritage through braids, locks, or curls that present in the absence of chemical intervention.

People bring their skills, expertise, and life experiences to their workplace, and no one should be forced to leave parts of themselves behind when they show up to work or school. Still, people are regularly pressured to do just that through explicit policies dictating how they should wear their hair. People also experience more subtle but pervasive forms of hair-based discrimination.

Before receiving a job

According to a 2023 research study, Black women’s hair is 2.5 times as likely as white women’s hair to be perceived as “unprofessional.” The same study finds that approximately two-thirds (66%) of Black women change their hair for a job interview. Among them, 41% changed their hair from curly to straight (Dove and LinkedIn 2023).

Similarly, an empirical study examined participant responses to hair texture by asking a racially diverse set of participants to review professional profiles and rate the candidates on competence and professionalism. The study found that candidates with curlier hair were less likely to be recommended for hire and scored lower in assessments of professionalism and competence (Duke 2020).

CaSandra Glover, formerly of Arkansas Advocates for Children and Families, shared her personal experience:

I remember on numerous occasions scrambling before interviews to ensure I had my weave or wig styled in a way that would fit into a white-dominated setting. I was afraid to be seen as less than or be stereotyped for the hair texture I was born with. I never felt I could truly be myself. In my current workplace, I even struggled with starting this job with a natural protective braid hairstyle…. Truthfully, this is an issue that I still struggle with and I praise myself for the courage to be myself regardless of their personal thoughts or opinions. I should be able to wear my hair naturally without any shame because my hair is my hair and it’s something I should be proud of.2

Isaiah Bailey of the Topos Partnership said:

There is long-standing community-wide trepidation as concerns the relationship between Black hair and professional success. To this day, my mother reminds me of the deal we made many many years ago—that I would cut my locs if my hair ever proved to be a hindrance to my professional pursuits. But I never actually intended to abandon my locs—I think they frame my face well. And more than that I came to view my mane as symbolic of my autonomy. It feels odd to say, but I was truly more committed to keeping my locs than scraping my professional ceiling. Maybe in a previous generation, I would’ve changed my tune. Likely. But I was fortunate to experience a time and place that respected my autonomy. Now the hope is that the CROWN Act will protect many more and for generations to come.3

In addition to examples of discrimination in the interview process, there are also many personal examples of hair discrimination surfacing even before students enter their careers. In the early 2020s, 9-year-old Ava Russell was sent home for wearing her curls down (Locke 2022) and Deandre Arnold was prevented from participating in his high school graduation ceremony because of his locks (Evelyn 2020).

Such requirements and preferences for Eurocentric hairstyling threaten Black and brown individuals’ ability to attain and maintain status as a student or employee.

At the workplace

Once work is secured, Black women with coily or textured hair are also twice as likely to experience microaggressions at work as Black women with straighter hair. Over 20% of Black women ages 25–34 have been sent home from their jobs due to their hair (Dove and LinkedIn 2023). Such “disciplinary” actions may culminate in termination from employment or make it difficult to advance to a higher-level position.

Hair discrimination occurs for Black and brown workers across different fields and occupations, both for workers in entry-level positions and workers highly seasoned in their careers. For instance, a 2013 lawsuit filed by the U.S. Equal Employment Opportunity Commission (EEOC) describes how Chastity Jones, a Black woman in Alabama, was offered a customer service position, only to have it rescinded after she refused to cut her locks (EEOC 2013). Later, an article in the Harvard Business Review discusses how clinical psychologist Donna Dockery struggled to select a hairstyle for her professional headshots, knowing that her choice would influence the likelihood of bias among those who saw the images (Asure 2023).

In addition to the professional and educational implications of hair discrimination, pressure on a worker or student to style their hair a certain way holds economic and health implications. Styling and maintenance for Black hair is deeply personal and a place where Black workers already invest a lot of energy and income, as evidenced through consumer spending. In 2022, Black consumers spent $2.3 billion on hair care, making it their largest category of beauty and skin purchases (NielsonIQ 2023). Mandating that people straighten their hair can come at sizable cost, with permanent straightening costing between $38 and $435 per session. In addition to the economic cost, forcing people to straighten their hair can also have negative health implications. Recent studies have linked straightening products to breast (Stiel et al. 2015) and uterine cancer (Chang et al. 2022). How each person styles their hair should be their choice.

The CROWN Act protects against hair-based discrimination

Discrimination against Black and brown people continues to be a pervasive element of American workplaces and schools. While the Civil Rights Act of 1964 added protections against race-based discrimination, it did not include protections against discrimination based on phenotypical markers that manifest race, such as hair texture. This has provided a loophole by which employers and schools can effectively engage in race-based discrimination.

The CROWN Act strengthens protections against hair-based discrimination for employees and students. It does so by expanding the definition of race in employment, housing, education, and other laws to include definitions of race as signified through hair—thereby protecting workers and students from hair-based racial discrimination.4 The protections address systemic racism in the workforce and help to avoid more severe consequence to the livelihoods of Black and brown people, such as losing a job or being prevented from pursuing an educational journey to a desired career.

The CROWN Act would add safeguards across the country to protect workers from discriminatory firing or punishment based on their expression of culture, religion, and identity through their hair. Language from the original bill specifies protected characteristics, explicitly listing and defining “protective hairstyles,” “national origin,” and “race” among these. The bill text declares that “race is inclusive of traits historically associated with race, including, but not limited to, hair texture and protective hairstyles.” The bill language also specifies that expressions of religious creed are protected, stating that “‘religious dress practice’ shall be construed broadly to include the wearing or carrying of religious clothing, head or face coverings, jewelry, artifacts, and any other item that is part of an individual observing a religious creed.”5

Why is the CROWN Act needed?

The CROWN Act impacts racial discrimination, pay equity, and just cause protections for people of various cultural backgrounds, but especially Black people. With over 31.6 million Black people in the U.S. labor force, the CROWN Act could help reduce discrimination for more than 12% of labor force participants (U.S. Census Bureau ACS 2021a).

As referenced in the studies above, the Act has a profound impact on Black women workers. There are 9.3 million Black women employed in the U.S. workforce. Over 44% of Black women currently employed in the United States live in states that have yet to pass the CROWN Act, as shown in Table 1. (Sixteen states are listed in Table 1. Ten additional states have not passed the CROWN Act but did not have sufficient data to list here.)

Table 1

Strengthening workplace protections for Black women may also help address pay inequity, especially between Black women and white men. In 2022, the median hourly wage for Black women was 69.5% that of the median hourly wage for white men. Over the span of a year, this equates to a $17,000 loss of income for a full-time worker (Gould and deCourcy 2023). This loss is equal to almost half (43.4%) of the typical yearly income for Black women and 36.1% of the median income for all U.S. workers (EPI 2023).

Finally, the CROWN Act is needed to help protect workers against discriminatory firing. Under the standard “at-will” system, employers can fire employees for little to no reason. The burden of proof falls on employees to prove discrimination. The CROWN Act helps workers challenge firings when there is evidence that hair-based discrimination is involved.

Few states have protections against firing without cause unless a union contract is in place. Union contracts generally include “just-cause” protections mandating that a legitimate reason be established when someone is fired. These protections make it more difficult for employers to fire workers for discriminatory reasons, such as hair discrimination. As seen in Figure A, workers are less likely to be covered by a union contract in the South, where 56% of Black Americans reside (Moslimani et al. 2023) and where many of the states that have not yet passed the CROWN Act are located.

Figure A

State of play: The CROWN Act has bipartisan support

The CROWN Act is currently law in 24 states (see Figure B) and more than 40 localities. State Senator Holly J. Mitchell (D-Los Angeles) introduced it in the California legislature in January 2019 and Gov. Gavin Newsom (D) signed it into law within six months.6 Most recently, the Michigan legislature passed the CROWN Act in June 2023 and sent the bill to Gov. Gretchen Whitmer (D) for signature.7 Michigan followed Texas, where the law was signed by Gov. Greg Abbot (R) in May.8 They joined Arizona, where Gov. Katie Hobbs (D) signed an executive order banning race-based hair discrimination in March,9 and Arkansas, where Gov. Sarah Huckabee Sanders (R) signed the CROWN Act into law in April.10

Figure B

At the federal level, the CROWN Act was most recently introduced in the 117th Congress by Rep. Watson Coleman (D-N.J.). It passed in the House in March 2022 with a vote of 235–189.11 Sen. Cory Booker (D-N.J.) subsequently presented it on the Senate floor, making a case for passage by unanimous consent.12 However, it did not pass the Senate. It has not been reintroduced in the 2023–2024 Congress.

Both state and federal movements are important in removing hair discrimination from the workplace and schools. Though federal passage would make it the law across the nation, passage at the local level can protect workers in those jurisdictions expeditiously and build momentum for federal passage. Senators in two-thirds (67%) of the states that have passed the CROWN Act (16 states)13 also sponsor the federal legislation, signaling a trend for advocates to note for future efforts.

Major cities are starting to pass the law at the local level, leading the way to state passage. In December 2020, New Orleans Mayor LaToya Cantrell (D) signed the CROWN Act into law at the municipal level14 before the state-level Louisiana law passed in June 2022.15 Lawmakers have passed the CROWN Act in major cities across the country—including in Ohio, Missouri, Georgia, Wisconsin, and Pennsylvania—paving the way for support at the state level.

The CROWN Act is a critical tool to fight discrimination

The CROWN Act is about ensuring dignity, respect, and protection for Black and brown workers and addressing systemic racism that continues to exist in employment. Policymakers, researchers, and advocates should continue to push for the CROWN Act’s passage at the local, state, and federal levels.

Notes

1. The CROWN Act is law in the following states: Alaska, Arizona, Arkansas, California, Colorado, Connecticut, Delaware, Illinois, Louisiana, Maine, Maryland, Massachusetts, Michigan, Minnesota, Nebraska, Nevada, New Jersey, New Mexico, New York, Oregon, Tennessee, Texas, Virginia, and Washington.

2. CaSandra Glover in an email message to the author, May 25, 2023. Glover advocated for the bill to pass in Arkansas along with affiliates from Arkansas Advocates for Children and Families (AACF). See Glover’s blog post, “The Importance of the CROWN Act,” on the AACF website.

3. Isaiah Bailey in an email message to the author discussing the impact of the CROWN Act, May 30, 2023.

4. California passed the original version of the CROWN Act, which has influenced bills in 23 other states. See S.B. 188, 2019–20 Assemb., Reg. Sess. (Cal. 2019) for the original bill text. The District of Columbia also protects against hair discrimination in the DC Human Rights Act.

5. S.B. 188, 2019–20 Assemb., Reg. Sess. (Cal. 2019).

6. S.B. 188, 2019–20 Assemb., Reg. Sess. (Cal. 2019).

7. S.B. 0090, 2023 Senate, Reg. Sess. (Mich. 2023).

8. H.B. 567, 2023 House, Reg. Sess. (Tex. 2023).

9. Exec. Order No. 2023-09 (Ariz. 2023).

10. H.B. 1576, 2023 House, Reg. Sess. (Ark. 2023).

11. H.R. 2116, 117th Cong. (2022). 

12. S. 888, 117th Cong. (2022).

13. These states include California, Connecticut, Delaware, Hawaii, Illinois, Maine, Massachusetts, Michigan, Minnesota, Maryland, New Jersey, New Mexico, Oregon, Nevada, New York, and Virginia.

14. Calendar No. 33, 184. 2020 City Council, Reg. Sess. (New Orleans 2020).

15. H.B. 1083, 2022 Louisiana House of Rep., Reg. Sess. (La. 2022).

References

Asure, Janice Gassam. 2023. “How Hair Discrimination Affects Black Women at Work.” Harvard Business Review, May 10, 2023.

Bureau of Labor Statistics (BLS). 2023. “Union Members—2022” (news release). January 19, 2023.

Chang, Che-Jung, Katie M. O’Brien, Alexander P. Keil, Chandra L. Jackson, Dale P. Sandler, and Alexandra J. White. 2022. “Use of Straighteners and Other Hair Products and Incident Uterine Cancer.” JNCI: Journal of the National Cancer Institute 114, no. 12 (December 2022): 1636–1645. https://doi.org/10.1093/jnci/djac165.

Dove and LinkedIn. 2023. CROWN 2023 Workplace Research Study.

Duke Fuqua School of Business (Duke). 2020. “Research Suggests Bias Against Natural Hair Limits Job Opportunities for Black Women.” Duke Fuqua Insights, August 12, 2020.

Economic Policy Institute (EPI). 2023. State of Working America Data Library. Accessed June 23, 2023.

Equal Employment Opportunity Commission (EEOC). 2013. “Mobile Catastrophic Insurance Claims Company Sued by EEOC for Race Discrimination over Hair Policy” (press release). September 30, 2013.

Evelyn, Kenya. 2020. “Texas School District Bars Black Student from Graduating with Dreadlocks.” The Guardian, January 23, 2020.

Gould, Elise, and Katherine deCourcy. 2023. “Gender Wage Gap Widens Even as Low-Wage Workers See Strong Gains.” Working Economics Blog (Economic Policy Institute), March 29, 2023.

Locke, Charley. 2022. “Six Kids Speak Out About Hair Discrimination.” New York Times Magazine, April 22, 2022.

Moslimani, Mohamad, Christine Tamir, Abby Budiman, Luis Noe-Bustamante, and Lauren Mora. 2023. Facts About the U.S. Black Population. Pew Research Center, March 2023. 

NAACP Legal Defense Fund. n.d. “Natural Hair Discrimination: Frequently Asked Questions” (web page). Accessed May 26, 2023.

NielsonIQ. 2023. Meeting the Needs of Black Beauty Consumers in 2023. February 17, 2023.

Stiel, Laura, Paris B. Adkins-Jackson, Phyllis Clark, Eudora Mitchell, and Susanne Montgomery. 2015. “A Review of Hair Product Use on Breast Cancer Risk in African American Women.” Cancer Medicine 2016, vol. 5, no. 3: 597–604. Revised November 17, 2015. https://doi.org/10.1002/cam4.613.

U.S. Census Bureau, American Community Survey (U.S. Census Bureau ACS). 2021a. Public data series accessed via ACS website. “Employment Status” (table). Accessed June 2023.

U.S. Census Bureau, American Community Survey (U.S. Census Bureau ACS). 2021b. Public data series accessed via ACS website. “Sex by Occupation for the Civilian Employed Population 16 Years and Over (Black or African American Alone)” (table). Accessed June 2023.

The problem: In October 2022, Kroger, the largest supermarket chain in the U.S., announced plans to acquire Albertsons, the second largest. The deal will reduce the number of outside employment options available to workers, lowering grocery store workers’ annual wages by a total of $334 million—about a $450 loss in annual wages per worker. 

What can be done about it:  In their rulings on the admissibility of mergers, anti-trust regulators like the Federal Trade Commission should consider wage losses stemming from increased labor market concentration, as well as the typical product market effects.

In October 2022, Kroger, the largest supermarket chain in the U.S., announced plans to acquire Albertsons, the second largest, for $24.6 billion—a deal that faces antitrust scrutiny from the Federal Trade Commission and state regulators.1 Historically, antitrust concerns have focused on the damage to consumers caused by concentration in product markets that gives large firms pricing power. However, a recent wave of economic research has called attention to potential damages to workers’ bargaining power over wages stemming from concentration in labor markets. In this policy memo, we discuss these labor market implications of the proposed merger. We find that the merger of two of the largest supermarket chains in the country will increase employer concentration and reduce the wages of all grocery store workers in affected cities across the country.

Workers’ ability to negotiate better pay and working conditions rests on their capacity to switch jobs. By decreasing the number of outside options available to workers, the merger will limit competition for hiring and retaining employees, and grocery store worker earnings will fall as a result. Crucially, the wage effects we identify are solely driven by this increase in labor market concentration. If the merger also leads to layoffs or hours cuts, this would add another dimension of damage to affected workers.

Our analysis uses grocery store employment and earnings data and the specific locations of Kroger and Albertsons stores. We find that:

• The merger will lower wages for 746,000 grocery store workers in over 50 metropolitan areas of the U.S. Increased concentration will suppress wages for all grocery store workers in affected cities—not only those workers currently employed by Kroger or Albertsons;
• The total annual earnings of grocery store workers will fall by $334 million in affected metropolitan areas;
• Because Kroger and Albertsons employ about one quarter of all grocery store employees, most of the wage losses caused by the merger will be a negative externality that falls on grocery store workers employed by other firms. On average, all grocery workers in affected markets will lose about $450 per year in wage income;
• Earnings losses will be smaller in areas with a stronger union presence or a tighter labor market. In areas with weaker worker bargaining power, workers will experience larger wage declines; and
• The expected earnings losses are a pure windfall for the employers. In our analysis, wages fall solely because of a change in labor market power brought about by increased concentration. Quantitatively, this windfall represents a significant transfer of income from wages to profits: The decrease in wages is equivalent to 2% of Kroger and Albertsons’ profits or three times the companies’ CEO compensation.

Analysis

Recent research has established that concentrated labor markets can reduce worker pay.2 As explained in Abdela and Steinbaum (2018), much of this research estimates the expected change in average wages for a given change in employer concentration in a particular industry- or occupation-specific labor market.

This analysis uses estimates from that research and applies them to labor markets, which we define as grocery store industry employers or employees in metropolitan areas using the 4-digit North American Industry Classification System (NAICS) industry 4451, Grocery and Convenience Retailers.3 For each of these metropolitan area labor markets, total grocery store wage losses are calculated by estimating percent changes in employer concentration due to the merger and multiplying those concentration changes by the wage responses estimated in the research literature described above.

To estimate the percent change in concentration due to the merger, we first estimate the level difference in the metropolitan area grocery store industry concentration before and after the merger and then divide that level change by an estimate of the baseline, pre-merger concentration.

To estimate the pre-merger concentration levels, we choose an average pre-merger concentration level by relying on the existing research literature that calculates trends in retail or grocery concentration. Measuring concentration as the Herfindahl-Hirschman Index (HHI) for 4-digit NAICS industries in commuting zones, Rinz (2022) found that the average HHI for the retail trade sector trended between 0.1 and 0.2 between 1976 and 2015.4 Zeballos, Dong, and Islamaj (2023) also calculated that the average HHI for two 6-digit industries associated with food retail markets in metropolitan areas rose from about 0.1 in 1990 to about 0.2 in 2019.5 In the following analysis, we choose a constant 0.15 as the average pre-merger concentration level in metropolitan areas for the grocery store industry. Coincidentally, 0.15 is the threshold at which the Department of Justice considers a market to be “moderately concentrated.”6

In our analysis, the pre- and post-merger difference in concentration levels assumes Kroger and Albertsons act as two separate firms prior to the merger and as one single firm after the merger, and then we calculate the level change in HHI where it is possible to estimate store-level employment for each Kroger and Albertsons store. This estimate is a linear prediction based on a subset of 153 stores for which we have employment estimates, square footage data, and Quarterly Census of Employment and Wages (QCEW) metropolitan area-level average employment per establishment.7

All told, this analysis covers 205 metropolitan areas containing 3,770 Kroger and Albertsons stores for which we can estimate store-level employment—and hence potential concentration changes—and for which we have 2022 QCEW data for baseline metropolitan area grocery store employment and earnings levels.8 According to the 2022 QCEW data, there are about 1.6 million grocery store workers in these cities and about 2.8 million grocery store workers nationwide. In 55 of these metropolitan areas, concentration will increase after the merger because these areas contain both Kroger and Albertsons stores.

Wages will fall on average for all grocery store workers in these areas due to the decrease in employer competition. (In other metropolitan areas, we assume there will be no wage change due to the merger because there is no estimated change in concentration.) The exact magnitude of the wage response is based on estimates published in Rinz (2022): Specifically, our analysis assumes that a 10% increase in concentration in a labor market will lower the average wage by 0.4%.9

Table 1 summarizes the results. The metropolitan areas with concentration increases contain 746,000 grocery store workers, and the total annual wage bill is $26.3 billion. Across these areas, earnings-weighted average concentration will increase by 32% because of the merger. As a result, wages will decline by 1.3%, given the assumed elasticity of wages with respect to a concentration of -0.04. The Kroger-Albertsons merger will cause annual wages to fall in these affected cities by a total of $334 million. On average, each of the affected 746,000 workers will lose about $450 in annual wage income.

Table 1

Because the wage losses will, on average, affect every grocery store worker in a metropolitan area where there is a merger of Kroger and Albertsons’ stores, cities with large grocery employment bases will experience particularly large losses in total wage income. Table 2 shows the 10 largest wage losses by metropolitan area. For example, the merger will cause annual grocery store wages to fall by $51 million in the Los Angeles-Long Beach-Anaheim, California, metropolitan area and $32 million in the Chicago-Naperville-Elgin, Illinois-Indiana-Wisconsin, metropolitan area.

Table 2

The effects described above represent average losses, and some individual workers may experience larger or smaller wage declines. In particular, the losses may be reduced in labor markets where workers have more bargaining power. Benmelech, Bergman and Kim (2022), in the case of manufacturing, and Prager and Schmitt (2021), in the case of hospital workers, show that the negative wage effects of employer concentration are larger in areas where union density is below average or right-to-work laws reduce unions’ bargaining power. For example, union coverage rates in the grocery store industry are only 8% in the South, but 20% in the Northeast.

As wage declines entail significant losses for grocery store workers, they simultaneously represent sizable parts of Kroger and Albertsons’ bottom lines. Some reports estimate total employment at Kroger and Albertsons to be about 710,000 workers, about one quarter of the total 2.8 million employees in the grocery store industry.10 Accordingly, a reasonable expectation for wage losses for employees at Kroger and Albertsons is one quarter of the $334 million, or about $84 million. Since Kroger’s profits were $2.3 billion and Albertsons profits were $1.5 billion in 2022, the merger-induced decline in grocery store worker wages is equivalent to about a 2% increase in Kroger and Albertsons’ profits.11 Because grocery profits were relatively high in 2022, the wage reductions would represent an even higher share of “normal” pre-pandemic profits. The wage losses also represent a significant windfall for company executives: Wage losses for workers at Kroger and Albertsons are about three times the size of the total CEO compensation of the two companies.12

Conclusion

The Kroger and Albertsons merger will reduce the number of outside employment options available to workers and place downward pressure on grocery store workers’ wages. Based on existing empirical research showing the labor market effects of employer concentration, we find that the merger will permanently reduce the wages of 776,000 grocery store workers. Their annual earnings will fall by $334 million—about a $450 loss in annual wages per worker. If unionization rates were significantly higher in areas affected by the merger, union contracts and bargaining power could mitigate some of these losses.

Notes

1. For rankings, see Selyukh 2022.

2. For example, see Azar et al. 2020; Azar, Marinescu, and Steinbaum 2022; Benmelech, Bergman, and Kim 2022; Prager and Schmitt 2021; Qiu and Sojourner 2022; and Rinz 2022.

3. Although this analysis uses metropolitan areas to define the geographic boundaries of labor markets, using commuting zones obtains a similar percent change in wages: Wages fall by 1.3% using metropolitan areas and by 1.1% using commuting zones. We use the 4-digit NAICS aggregation level to define the grocery store industry because 4-digit NAICS industry groups underlie the analysis in Rinz 2022.

4. See Appendix Figure C14 in Rinz 2022.

5. See Figure 2 in Zeballos, Dong, and Islamaj 2023.

6. See U.S. Department of Justice 2018. Our analysis assumes a latent concentration level of 0.15—the midpoint of the average range 0.1 to 0.2 described in the text—yielding an estimated annual wage loss of $334 million. If we chose a different latent concentration level between 0.1 and 0.2, our estimated annual wage loss would lie between $250 million and $501 million.

7. The data on store locations, store square footage, and store employment was provided by analysts at the United Food and Commercial Workers International Union. For 153 stores for which we have both employment and square footage data, we regress log of employment on the log of square feet and log of QCEW employment per establishment and the interaction of the latter two terms. The fitted model has an R-squared value of 0.31. We use this model to predict employment at all Kroger and Albertsons stores.

8. While there are closer to 5,000 total Kroger and Albertsons stores, we examine only 3,770 stores because: (1) Some stores are in lower population regions that are not classified as metropolitan areas; (2) some stores are in areas for which area-wide grocery store employment and earnings data is suppressed in the QCEW; and (3) some stores we lack the square footage data used to estimate store-level employment. If additional data for these stores were available, they would mechanically raise the estimated increase in concentration and therefore increase the magnitude of associated wage losses.

9. The mean elasticity of wages with respect to HHI in Table 4 of Rinz 2022, columns 1 and 3, is -0.04.

10. See Selyukh 2022.

11. See Kroger Corporate 2023 and Albertsons Corporations 2023.

12. Kroger CEO compensation in 2021 was about $18 million, and Albertsons CEO compensation in 2021 was about $8.6 million. See Coolidge 2022 and Exec Pay 2021.

References

Albertsons Companies. 2023. “Albertsons Companies, Inc. Reports Fourth Quarter and Full Year Results” (press release). April 11, 2023.

Abdela, Adil, and Marshall Steinbaum. 2018. Labor Market Impact of the Proposed Sprint–T-Mobile Merger. Economic Policy Institute, December 2018.

Azar, José, Ioana Marinescu, and Marshall Steinbaum. 2022. “Labor Market Concentration.” Journal of Human Resources 57, no. S: S167—S199.

Azar, José, Ioana Marinescu, Marshall Steinbaum, and Bledi Taska. 2020. “Concentration in US Labor Markets: Evidence from Online Vacancy Data.” Labour Economics 66, October: 101886.

Benmelech, Efraim, Nittai K. Bergman, and Hyunseob Kim. 2022. “Strong Employers and Weak Employees.” Journal of Human Resources 57, no. S: S200–S250.

Coolidge, Alexander. 2022. “Kroger CEO Rodney McMullen Saw Pay Cut in 2021, While Worker Pay Rose.” Cincinnati Enquirer, April 27, 2022.

U.S. Department of Justice. 2018. “Herfindahl-Hirschman Index” (web page). July 31, 2018.

Exec Pay. 2021. “Vivek Sankaran” (web page). Accessed March 2023.

Kroger Corporate. “Kroger Reports Fourth Quarter and Full-Year 2022 Results Announces Growth Expectations for 2023” (press release). March 2, 2023.

Prager, Elena, and Matt Schmitt. 2021. “Employer Consolidation and Wages: Evidence from Hospitals.” American Economic Review 111, no. 2: 397–427.

Selyukh, Alina. 2022. “Kroger and Albertsons Plan Merger to Combine 2 Largest Supermarket Chains.” NPR, October 14, 2022.

Qiu, Yue, and Aaron Sojourner. 2022. “Labor-Market Concentration and Labor Compensation.” ILR Review 76, no. 3: 475–503.

Rinz, Kevin. 2022. “Labor Market Concentration, Earnings, and Inequality.” Journal of Human Resources 57, no. S: S251–S283.

Zeballos, Eliana, Xiao Dong, and Ergys Islamaj. 2023. A Disaggregated View of Market Concentration in the Food Retail Industry. Economic Research Report 314, USDA Economic Research Service, January 2023.

The problem: Congress is gridlocked in large part because of the Senate filibuster. Even bills that enjoy broad public support—for example, proposals to raise the federal minimum wage—are unable to pass through Congress.

What can be done about it: The most direct way to break gridlock in the U.S. Senate would be to abolish the filibuster. Failing that, the second-best option would be to expand the scope of reconciliation to allow a broader range of nonbudgetary measures to pass through Congress.

Republicans have only a razor-thin majority in the U.S. House of Representatives, while Democrats have a 51–49 majority in the U.S. Senate. Under these circumstances, it should in theory be possible to pass broadly popular legislation through the 118th Congress.

In practice, however, the Senate filibuster will continue to block policymakers from making progress with such legislation. Sixty votes are required to break and move past the filibuster. The filibuster’s expanded use in recent decades has made it radically more difficult for even significant Senate majorities to move legislation.

One tool of Senate procedure—the budget reconciliation process—provides a limited end run around the filibuster. The reconciliation process allows a certain subset of legislation to pass with a simple majority.

One feature of the reconciliation process—the so-called Byrd Rule—limits its scope to budget-related measures. However, the criteria for what types of bills should or should not be allowed to proceed under the Byrd Rule is highly subjective.

The most direct way to restore majority rule and break gridlock in the U.S. Senate is to abolish the filibuster. However, short of that, one could still allow a simple majority to pass a broader range of legislation than it currently can by expanding the scope of what is allowed to proceed under the expedited rules of reconciliation. While this is a suboptimal path, it would be far better than the status quo.

In this report, we argue that the criteria currently interpreted as dictating what legislation can proceed under the auspices of reconciliation are arbitrary, incoherent, and outright damaging. Given this, the carve-out from the filibuster’s reach offered to (some) fiscal measures in the Senate under the current rules of reconciliation has no particular logic and protects far too few potentially popular legislative proposals from Senate gridlock.

Consequently, the Senate should either abolish the filibuster for the vast majority of legislation, or, second best, greatly expand the scope of reconciliation to allow many pieces of legislation to pass under its auspices that would have in earlier periods been ruled out of reconciliation’s scope.

Our argument rests on the following points:

• There is a perception that federal budget changes have larger impacts on the economy than other legislation. The history of the budget reconciliation process and the Byrd Rule strongly suggests that they were instituted in response to this perception.

• But this perception is incorrect. Many legislative changes that older conventional wisdom would have argued were outside the bounds of budget reconciliation have profound effects in shaping the trajectory and distribution of economic growth. Given this, there is no reason even on narrow economic grounds to privilege budget-related rules over other rules that affect economic outcomes.
• The Byrd Rule’s explicit bias toward deficit reduction has not proved useful even for the narrow goal of reducing deficits. Narrow Republican majorities have been able to game the rule to allow large, sustained regressive tax cuts to pass in the past 20 years, which have increased budget deficits substantially.

• The goal of always biasing policy toward deficit reduction is itself misguided. Sometimes deficits should be made smaller to foster economic growth, but sometimes they should be made larger. For most of the past three decades, the U.S. economy has faced chronic shortfalls of aggregate demand relative to productive capacity. (These shortfalls are sometimes labeled “secular stagnation.”) This means that larger deficits would have been useful over that time. The past two years have seen evidence of a demand shortfall fade away, but it is possible that the longer-run trend of secular stagnation will reassert itself before too long.
• To achieve smaller deficits while also providing a counter to chronic shortfalls in demand, it makes sense to allow a broader range of measures—including nonbudgetary measures that would boost aggregate demand—to pass under the auspices of the Byrd Rule.
• The most obvious drawback to expanding the scope of reconciliation is that it compacts much of an entire year’s legislative agenda into a single vehicle. This potentially short-circuits a thoughtful policymaking process around each individual plank of a reconciliation bill and could lead to poorly crafted bills. Crucially, however, the drawbacks of the reconciliation process have minimal impact on policies that are straightforward, like increases in the federal minimum wage or labor law reform.

This report is organized as follows: First, we provide a short history of the budget reconciliation process and the Byrd Rule. Second, we critically examine the reconciliation process’s privileging of fiscal-related legislation. Third, we critically examine the Byrd Rule’s bias toward deficit reduction. Fourth, we identify a counterargument against expanding the scope of the reconciliation process, and we examine this criticism’s applicability to using reconciliation to pass a federal minimum wage increase or fundamental labor law reform. We conclude that reconciliation, while suboptimal, is nevertheless a useful tool for breaking gridlock to pass legislation that is straightforward and has popular support.

The budget reconciliation process and the Byrd Rule

Today’s budget reconciliation process is the result of the Congressional Budget Act (CBA) of 1974 and the subsequent adoption of the “Byrd Rule” in 1985.1 Before 1974, the filibuster could be applied to budget bills in the U.S. Senate. The Congressional Budget Act of 1974 made significant changes to the federal budgeting process, most intended to shift power for making and enforcing budgetary decisions away from the executive branch and toward Congress. One key impediment to Congress asserting more influence in the budget-making and enforcement process was a minority’s ability to filibuster budget-related bills and hence cause legislative gridlock.

Between 1974 and 1985, the availability of a new fast-track procedure to pass bills that could not be filibustered eroded the supermajoritarian norms of the Senate. In response, a prominent defender of these norms—Sen. Robert Byrd (D-W.Va.)—introduced the “Byrd Rule,” putting limits on what could be included in budget reconciliation bills.

The most important provision of the Byrd Rule for today’s political debates was the one that disallowed “extraneous” legislation from being included in budget reconciliation bills. One key Byrd Rule definition states that legislation “is considered to be extraneous if it…produces a change in outlays or revenues which is merely incidental to the non-budgetary components of the provision” (CRS 2022, 5).

This is the part of the Byrd Rule that defenders of the current conventional wisdom regarding its reach say disallows a federal minimum wage increase or labor law reform to pass under its auspices. This interpretation should be rejected, as it often leads to incoherent outcomes. For example, the current interpretation of the Byrd Rule’s “extraneous” exclusion rules out some bills that have larger fiscal effects than previous bills passed under reconciliation. For example, Zipperer, Cooper, and Bivens (2021) surveyed evidence showing that raising the federal minimum wage to $15 by 2025 would likely reduce public expenditures by roughly $10 billion annually. This is several times the size of the fiscal effect of a provision allowed to pass under reconciliation in 2006—opening up the Arctic National Wildlife Refuge (ANWR), which was forecast to boost federal revenues by about $2.5 billion over a three-year period (CBO 2005).2 Hence, even on its own terms of privileging legislation with significant fiscal effects, the Byrd Rule is inconsistently applied.

Beyond this, the prohibition on economic measures with only “extraneous” effects on fiscal policy highlights that past policymakers thought that fiscal measures were the most important way congressional action affects the economy. However, this is incorrect.

In addition, the explicit target of the Byrd Rule’s “extraneous” tests was deficit reduction, but imparting a bias toward deficit reduction in the congressional budget process is unwise. Finally, despite this bias toward deficit reduction embedded in the Byrd Rule, Republican majorities have managed to sidestep the rule multiple times in the past to enact large tax cuts.

There is no convincing economic rationale for privileging budgetary bills in the legislative process

By most accounts, a precipitating event leading to the CBA of 1974 was the Nixon administration’s refusal to spend money that had been appropriated by Congress. For example, the Nixon administration refused to disburse funds from the Environmental Protection Agency (EPA) that Congress had appropriated for distribution to states to invest in clean water efforts. This impoundment of funds in defiance of Congress was indeed an abuse of executive power and one that was properly rectified by congressional action.3

But Congress noticed and reacted to this impoundment only because revenue and spending flows are more visible to them than other economic influences that are under the joint control of Congress and the executive branch. It is not obvious, however, that more visible means more important. The Nixon impoundment of funds that attracted the ire of Congress was related to legislation aimed at boosting environmental quality. Yet there are other ways besides outright impoundment of appropriated funds through which the executive branch can frustrate the intent of Congress to improve environmental quality. For example, it has been widely agreed upon by historians of environmental policy that the Reagan administration’s EPA gutted the effectiveness of environmental protections through lax enforcement and the redistribution of resources within agencies to activities that slowed enforcement of regulations.4 This begs the question: Why should a fast-track legislative remedy be available for executive branch fiscal actions that impede the improvement of environmental quality but not for regulatory actions?

There is a common perception that tax and budget policy is the most important policy tool available to Congress to achieve their goals. If this were true, then privileging tax and budget policy through the reconciliation process would make some sense. But this is not true. The U.S. economy, and the economic security of typical U.S. families, is profoundly shaped by policies passed by Congress that do not see their first-order effects run through changes in the federal budget. Once the full scope of these policies’ effects is recognized, the case for privileging one subset of economic policies (those that deal with taxes and spending) over others stops making sense.

This is perhaps most easily illustrated by looking at a very broad measure of rising inequality in the U.S. economy in recent decades: the ratio of median to average household incomes. Using data from the Congressional Budget Office (CBO 2022), Banerjee and Bivens (2022a) show that the share of post-tax-and-transfer income claimed by the middle 60% of households fell by over 6 percentage points between 1979 and 2018.5 Yet tax rates fell while transfer rates rose for these households over this time, and at a faster rate than for average incomes.

So why did inequality rise if the federal budget and tax system became more equalizing over this time? Because market incomes became far more unequal and this rising inequality of market-based incomes swamped any equalizing effect of fiscal redistribution. The share of pre-tax-and-transfer income claimed by the middle 60% fell by nearly 9 percentage points over the same time period. What happened in the market mattered far more for economic outcomes than what happened to the federal budget and taxes for the majority of middle-class families.

What does congressional action have to do with the evolution of market income over this time? Bivens and Mishel (2021) show that a number of specific policy decisions can explain most of the rise in market inequality over this time. Key among these are the declining inflation-adjusted value of the minimum wage and the failure to enforce the right of U.S. workers to form unions and bargain collectively. The decline in unionization by itself likely lowered median hourly wages by almost 8% between 1979 and 2017. Given that labor earnings make up the overwhelming majority of market income accruing to the median household, the decline of unions can account for a large portion of the decline in median income relative to average.

In turn, the decline of unionization in the U.S. economy can be accounted for by policy decisions, either of commission (passing anti-union “right to work” laws at the state level) or of omission (failing to protect the right of private-sector workers to organize unions in the face of growing employer hostility).

Bivens and Mishel (2021) also highlight the role of macroeconomic policy in driving the rise of inequality in recent years. Importantly, this macroeconomic policy has been driven by the decisions of the Federal Reserve. The Federal Reserve Board of Governors is confirmed by the Senate, and congressional committees have oversight of the Fed.

Finally, Banerjee and Bivens (2022a) highlight evidence that the sharp rise in pre-tax-and-transfer inequality has by itself had profound effects on both the pace of overall economic growth and the fiscal stance of the federal government. As rising inequality concentrates more of the nation’s total income in households at the top of the income distribution with higher savings rates, this will—all else equal—slow growth in aggregate demand. If no countervailing support to demand growth springs forth, this will translate into a binding constraint on overall economic growth. Banerjee and Bivens (2022a) find that rising inequality since 1979 was by 2019 reducing aggregate demand growth by up to 2% of gross domestic product (GDP) annually. For most of the years post-2000, this almost surely translated directly into significantly reduced growth overall.

In short, Congress has shaped many crucial policies that have driven economic outcomes in recent years even outside the area of tax and budget policy. In fact, changes in market incomes over recent decades have driven income trends far more than changes in taxes and transfers. Given this reality, the idea that Congress needs a privileged way to fast-track tax and budget policies while other policies languish makes very little sense. The modern U.S. economy needs a Congress able to legislate across all relevant policy areas.

The intended Byrd Rule bias toward fiscal contraction is misguided but could be partially alleviated by allowing more policies to pass through the reconciliation process

It is widely agreed upon by historians of the budget reconciliation process that both the CBA of 1974 and the Byrd Rule were driven largely by hopes that they would aid the process of deficit reduction. Most concretely, the Byrd Rule disallows any legislation that adds to long-run increases in federal budget deficits (with “long run” traditionally defined as outside the 10-year budget window traditionally used for scoring legislation). This intended bias toward deficit reduction reflected a conventional wisdom that public debt restraint was nearly always and everywhere an economic good (expect perhaps during outright recessions). But, in fact, since the permanent codification of the Byrd Rule in 1990, the economic case for needing painful deficit reduction has been substantially weakened, yet the bias in the Byrd Rule toward deficit reduction remains.

The data signature that would indicate that deficits are harming economic growth is supposed to be rising interest rates. Yet extraordinarily weak economic growth between 2000 and 2019 led to very large rises in public debt but continued rapid declines in interest rates, making the imperative for painful deficit reduction (even during times of economic growth) much less pressing.6

This confluence of weak growth and low interest rates was driven by a larger factor—a chronic shortfall of aggregate demand relative to the economy’s productive capacity. This demand shortfall—sometimes labeled “secular stagnation”—was the primary constraint on economic growth for the two decades before the COVID-19 recession.

The recovery from the COVID-19 recession has seen a reversal of many of the data signatures of secular stagnation—interest rates have risen as the Fed has sought to contain the largest outbreak of inflation in nearly 40 years. However, it does not follow automatically from this episode of high inflation and higher interest rates that secular stagnation is decisively over, for a couple of reasons. For one, secular stagnation was always a background condition of the economy that could be overcome with enough policy force. The problem was insufficient spending, and any policy that boosted spending (like deficit-financed federal spending) could overcome this problem.7

For another, the COVID-19 recovery saw a sharp decline in the economy’s productive capacity as labor force participation declined and rolling supply chain disruptions snarled the ability to manufacture and produce goods. This decline in supply helped “solve” the gap between aggregate demand and the economy’s productive capacity. But these supply declines are highly likely to be temporary. In the U.S., labor force participation has steadily climbed back to near pre-COVID trends, and supply chains (at least before the recent COVID-19 outbreak in China) have been healing rapidly.

Whether one thinks that the reprieve from the condition of secular stagnation in 2021 and 2022 was the result of extraordinarily rapid demand growth (spurred by large fiscal policy interventions) or the result of shocks from the COVID-19 pandemic and the Russia-Ukraine war, the reprieve seems likely to be temporary. Nothing fundamental occurred to change the underlying condition (for example, a rollback of the post-1979 rise in inequality was not achieved), so secular stagnation is likely to persist as the economy returns to more normal conditions going forward. In a few years, the Byrd Rule bias toward fiscal contraction is likely to be as un-useful as it was in the two decades before the COVID-19 shock.

The Byrd Rule in practice has restrained spending increases, not tax cuts

It has often been argued—and not just by anti-government ideologues—that the more politically difficult part of deficit reduction is spending restraint.8 Yet the recovery following the Great Recession of 2008 was the most austere on record for public spending—both at the federal and subfederal levels. This spending austerity was deeply damaging to the recovery from that recession, yet it persisted well into the recovery, largely relenting only by 2017.

In short, recent decades have not seen a steady upward ratchet in spending programs that have led to larger budget deficits. Instead, the trend has been toward spending that is too austere given the needs of the economy.

This problem is exacerbated by Byrd Rule provisions that ostensibly allow only deficit-neutral or deficit-reducing policies to pass under its auspices.

Yet while the Byrd Rule has been used to restrain spending in the name of deficit reduction, it has failed to stop Republican majorities from passing large regressive tax cuts that add considerably to deficits. Three times in the past two decades narrow Republican Senate majorities were able to flagrantly game loopholes in the Byrd Rule to pass large tax cuts.

These tax cuts had major fiscal implications, but they did little to solve the chronic shortfall of aggregate demand holding back growth. That’s largely because higher-income households that see disproportionate gains from these tax cuts have a high propensity to save rather than spend additional disposable income.9

The failure of the Byrd Rule to stop these large regressive tax cuts shows just how asymmetric the rule has been in putting pressure on deficit reduction, strongly favoring downward pressure on spending while not stemming revenue losses.

All in all, to the degree that the Byrd Rule has provided much enforcement at all of deficit reduction measures, it has been on the spending side.10 That has meant that it has proved maximally damaging during times when the economy is demand constrained.

Some reconciliation process downsides could be avoided if the process allowed a broader range of policies to pass

Above we identified two key problems with the Byrd Rule status quo. First, nonbudgetary policy changes have enormous effects on economic well-being and need to be addressed at least as urgently as budgetary changes—and yet they can’t be addressed under the current interpretation of the rule. Second, the Byrd Rule bias toward deficit reduction nudges fiscal policy to be more contractionary even as chronic demand shortfalls have made such contraction damaging in recent decades.

These problems would be alleviated by allowing a broader scope of policy changes to pass through the budget reconciliation process. For one, expanding the scope of legislation allowed under reconciliation would allow needed nonfiscal policy changes to escape filibuster-imposed gridlock. For another, many proposed nonfiscal changes would boost economywide spending and solve the problem of deficient demand.

Two high-profile policy changes that the incoming Biden administration has announced support for would be of particular help: a significant increase in the federal minimum wage and reform of labor law to secure workers’ rights to join unions and bargain collectively.

Both of these policy changes would result in a significant redistribution of income downward, reversing some of the previous decades’ rise in inequality. In the long run, the combined effect of these two interventions on average income growth for households in the bottom half of the income distribution could be as large as any single fiscal policy change enacted since Medicare and Medicaid were created in the mid-1960s.11 Given this, it is hard to understand why Congress has maintained a privileged legislative process for purely fiscal measures when nonfiscal measures can have such a profound effect on living standards.

This downward redistribution of income would also go far in alleviating the chronic shortfalls of demand that have characterized the last quarter century in the U.S. economy. Banerjee and Bivens (2022a), for example, have shown that rising inequality that boosted the income share of higher-income (and hence higher-saving) households has exerted a huge drag on demand growth since the late 1980s. Bivens and Mishel (2021) have shown that this large upward redistribution has been driven overwhelmingly by policy changes that affected the labor market. In short, policy changes that boosted the bargaining power of the bottom 90% of the labor market and led to faster broad-based wage growth would likely raise aggregate demand measurably. This would make the Byrd Rule’s bias toward fiscal contraction less damaging.

Even under narrow budgeting-based views of the Byrd Rule, higher minimum wages and fundamental labor law reform have significant fiscal effects

Part of what makes the Byrd Rule’s barring of “extraneous” provisions so arbitrary is that many policy changes that do not see their first-order effects run directly through revenue or spending still end up having quite large fiscal impacts. In fact, the fiscal impacts of both a higher minimum wage and fundamental labor law reform are nearly guaranteed to be substantially larger than allegedly more direct “fiscal” measures that have been passed under reconciliation.

For example, Zipperer, Cooper, and Bivens (2021) highlight a range of evidence showing that, all else equal, higher federal minimum wages lead to reductions in public expenditures. For a federal minimum wage of $15, these public expenditure reductions would be significant—on the order of $10 billion annually or more. The mechanism that links higher minimum wages to reduced public expenditures is fairly direct: Higher labor incomes would push some workers and their families over the threshold for receipt of certain public assistance program benefits or would reduce the size of tax credits they receive, such as the Earned Income Tax Credit (EITC) or the Child Tax Credit (CTC).

The fiscal effects of fundamental labor law reform are equally clear. One example of this type of fundamental labor law reform is the prohibition on state “right to work” (RTW) laws contained in the Protecting the Right to Organize (PRO) Act. There is ample evidence that RTW laws lead to reductions in unionization rates at the state level. Ellwood and Fine (1987) estimate that adoption of RTW laws in a state results in a permanent reduction in the share of the workforce that is represented by a union in that state of up to 3 percentage points. Given that more than 40% of the U.S. workforce in 2019 lived in RTW states, this implies a reduction in the overall unionization rate of 1.2%, or about 3 million workers not in unions due to the influence of RTW laws. Fortin, Lemieux, and Lloyd (2021) find similar effects in an event-study analysis of more recent movements of states into right-to-work status: Within five years of a state’s change in status, the share of workers in the state who are unionized falls by roughly 3 percentage points.

Sojourner and Pacas (2018) have found that unionized workers pay $2,800 more in taxes annually than nonunionized workers and that they receive $350 less annually in transfer payments. Multiplying the 3 million workers deprived of union coverage through the direct influence of RTW laws by the $2,800 in additional taxes paid by unionized workers implies that tax receipts are more than $8 billion lower due to the influence of RTW statutes. Meanwhile, public transfer payments are $1 billion higher. If the PRO Act provisions to bar the use of RTW laws reverse these causal effects, there would a large and direct fiscal impact.

Moreover, there is plenty of reason to believe that the PRO Act’s fiscal effects could be far larger than this. For example, the Ellwood and Fine (1987) estimates could well be an understatement of the long-run effect of RTW laws. As a raw average, unionization rates in RTW states are 50% lower than rates in non-RTW states. It is true that not all of this difference is the causal effect of RTW laws, but analyses looking at short periods of time or specific margins of adjustment might understate the true extent of this causal relationship. Ellwood and Fine, for example, note that their estimate could be an understatement because it looks only at the effect of RTW on new union organizing. But if the free-rider problems associated with the introduction of RTW laws encourage more rapid deunionization of previously unionized workplaces, or if RTW laws make it more likely that new businesses opening in the state will be nonunion, then the RTW effect will be larger.

More importantly, the PRO Act does more to potentially boost unionization rates than simply roll back RTW laws. It provides tougher penalties for a range of employer behaviors routinely undertaken to thwart union-organizing efforts.12 Given growing employer hostility toward unions and the effectiveness of employer actions in thwarting unionization efforts, it seems clear that the PRO Act could boost the share of workers represented by a union in the U.S. labor market significantly over the long run.

If, for example, the PRO Act resulted in an increase of 5% in the share of the U.S. workforce represented by a union, and the fiscal effects estimated by Sojourner and Pacas (2018) held, this would imply a boost to tax revenues of over $40 billion annually, along with a reduction in transfer expenditures of nearly $5 billion. These effects are larger than the vast majority of items allowed through the reconciliation process.

Broadening reconciliation, while suboptimal, works well for many issues

It’s worth repeating that the best way to restore majority rule to the U.S. Senate is to abolish the filibuster. Broadening the range of bills allowable under the reconciliation fast-track process is just a second-best option to that. But if the politics of the moment allow only second-best solutions, they should be undertaken, as they are clearly preferable to the status quo.

The most convincing counterargument to using reconciliation for an expanded array of potential legislation is that the process is already so crowded that it degrades the policymaking process, leading to poor policy design that is overlooked until too late. There is a grain of truth to this. Reconciliation can be used only once per year (generally), so this puts enormous pressure on policymakers to crowd as many different pieces of legislation into the single reconciliation bill as possible. Because these different (and often complex) pieces of legislation go all at once into the same policy debate and follow the same timeline, an extended policy process—in which expert consultation and debate over each provision can happen—is short-circuited.

An obvious recent example of this involved what is commonly known as the Tax Cuts and Jobs Act (TCJA) from 2017. The reconciliation process was used to push through a permanent reduction in corporate income tax rates as well as dozens of temporary changes in other parts of the federal tax code. Among many other technical corrections made after its passage, one provision of the TCJA—the “retail glitch”—had to be fixed as part of the Coronavirus Aid, Relief, and Economic Security (CARES) Act in 2021.13 The retail glitch unintentionally raised effective tax rates on a wide range of businesses by extending the time period over which durable assets could be depreciated in the tax code.

It is fair to weigh the benefits of allowing more responsive government against the costs of giving insufficient attention to complex policy changes. But the status quo does not just give insufficient space for debating many potentially desirable policy changes, it gives them effectively no space at all.

Further, there are a whole host of policy changes that are extremely well understood, that have been subject to great expert scrutiny, and that are broadly popular—yet they cannot get past a Senate filibuster. Two obvious ones are an increase in the federal minimum wage and labor law reform like the Protecting the Right to Organize (PRO) Act. The minimum wage increase in particular may be the most studied and debated federal policy change ever.14 The idea that great uncertainties exist in how it will affect the economy or how it might be implemented seems hard to credit.

On labor law reform, the effect of the PRO Act’s planks is straightforward. The PRO Act will make it easier for workers to form unions. Whether the outcome of more workers being able to form unions is a good thing for the U.S. economy is a fair subject for debate, but that does not make the PRO Act particularly complex. Nobody, for example, supports greater unionization in the U.S. economy but is against the PRO Act on the grounds that it’s so complex that it might through unintended consequences actually reduce unionization.

In short, both changes to the federal minimum wage and measures to boost the unionization rate in the U.S. economy are straightforward policies that should be allowed to move forward through an expansion of the reconciliation process. These policies would have profoundly progressive impacts on the U.S. economy and are at least as relevant to working peoples’ lives as the vast majority of bills that have been ushered through reconciliation in recent decades.

Conclusion and policy recommendations

Again: Abolishing the filibuster would be the simplest and most effective way to allow popular legislation to have a chance of actually moving through the U.S. Senate. However, given the limited time window for this Congress and the Biden administration to make progress on an effective economic policy agenda, and given the political resistance of some senators to abolishing the filibuster on principle, policymakers should consider all other options realistically available to them.

As they finalize the rules and procedures for the 118th Congress, Senate Democratic leadership should expand the scope of reconciliation. The economic assumptions used in the past for adopting the Byrd Rule are not borne out in reality. The status quo limitations on the types of policies considered under reconciliation need not continue to artificially constrain the Senate. The Senate should be enabled to pass much needed economic legislation with the support of a simple majority.

Notes

1. CRS 2022 is a good overall primer on the budget reconciliation process and the Byrd Rule.

2. See Cannan 2013 for a discussion of the use of reconciliation to pass ANWR.

3. This interpretation that the 1974 CBA legislation reestablished congressional control over federal budgets in the face of legislative impoundment is apparent on the Congressional Budget Office website today (https://www.cbo.gov/about/history).

4. See Fredrickson et al. 2018 for this history of EPA enforcement being thwarted by executive actions.

5. Author’s analysis based on Banerjee and Bivens 2022a.

6. On the sharp fall in interest rates and the relationship to fiscal policy, see Furman and Summers 2020.

7. On the likelihood that the forces generating the chronic shortfall of demand might return in coming years, see Banerjee and Bivens 2022b.

8. Probably the clearest statement of this outlook comes from former Federal Reserve Chair Alan Greenspan’s testimony before the Senate Budget Committee in 2001. In that testimony, Chair Greenspan discussed projected budget surpluses that he thought to be too large. To deal with these projected budget surpluses, he recommended: “In general, as I have testified previously, if long-term fiscal stability is the criterion, it is far better, in my judgment, that the surpluses be lowered by tax reductions than by spending increases…history illustrates the difficulty of keeping spending in check…. Moreover, the greater the drain of resources from the private sector, arguably, the lower the growth potential of the economy” (Greenspan 2001).

9. On the high fiscal cost but small economic effect of regressive tax cuts, see Bivens and Fieldhouse 2012.

10. See Cannan 2013 for a legislative history of the Affordable Care Act (ACA). The reconciliation process was eventually utilized in the process of legislating the ACA. Because the Byrd Rule requires that fiscal measures not increase the deficit, and because there was a politically driven limit imposed on how much revenue could be raised for the ACA, the reconciliation process and the Byrd Rule became a binding constraint on how much spending could be included in the ACA.

11. Cooper, Mokhiber, and Zipperer (2021), for example, found that an increase in the federal minimum wage to $15 by 2025, for example, would likely have raised wages for affected workers by over $100 billion in 2025.

12. See McNicholas et al. 2019 for documentation of employer hostility to union-organizing drives and how straightforward policy changes could lead to more successful unionization efforts.

13. See CRS 2021 on the retail glitch as well as a host of other technical corrections that needed to be made after passage of the TCJA.

14. See Dube 2019 for evidence that the effects of minimum wages have been thoroughly studied.

References

Banerjee, Asha, and Josh Bivens. 2022a. Inequality’s Drag on Aggregate Demand: The Macroeconomic and Fiscal Effects of Rising Income Shares of the Rich. Economic Policy Institute, May 2022.

Banerjee, Asha, and Josh Bivens 2022b. Will Secular Stagnation Return? The Stakes for Current Economic Debates and Fiscal Policy. Economic Policy Institute, August 2022.

Bivens, Josh, and Andrew Fieldhouse. 2012. A Fiscal Obstacle Course, Not a Cliff: Economic Impacts of Expiring Tax Cuts and Impending Spending Cuts, and Policy Recommendations. Economic Policy Institute, September 2012.

Bivens, Josh, and Lawrence Mishel. 2021. Identifying the Policy Levers Generating Wage Suppression and Wage Inequality. Economic Policy Institute, May 2021.

Cannan, John. 2013. “A Legislative History of the Affordable Care Act: How Legislative Procedure Shapes Legislative History.” Law Library Journal 105, no. 2.

Congressional Budget Office (CBO). 2005. CBO’s Official Estimate of Bonus Bids from Leasing ANWR. Letter to Sen. Ted Stevens (R-Alaska) from CBO Director Douglas Holtz-Eakin.

Congressional Budget Office (CBO). 2022. The Distribution of Household Income, 2019. November 2022.

Congressional Research Service (CRS). 2021. “Technical Corrections” and Other Revisions to the 2017 Tax Revision (P.L. 115-97). CRS Report no. R46754, April 2021.

Congressional Research Service (CRS). 2022. The Budget Reconciliation Process: The Senate’s “Byrd Rule.” CRS Report no. RL30862, September 2022.

Cooper, David, Zane Mokhiber, and Ben Zipperer. 2021. Raising the Federal Minimum Wage to $15 by 2025 Would Lift the Pay of 32 Million Workers: A Demographic Breakdown of Affected Workers and the Impact on Poverty, Wages, and Inequality. Economic Policy Institute, March 2021.

Dube, Arindrajit. 2019. Impacts of Minimum Wages: Review of the International Evidence. Report to the United Kingdom Low Pay Commission, November 2019.

Ellwood, David, and Glenn Fine. 1987. “The Impact of Right-to-Work Laws on Union Organizing.” Journal of Political Economy 95, no. 2.

Fortin, Nicole, Thomas Lemieux, and Neil Lloyd. 2021. “Labor Market Institutions and the Distribution of Wages: The Role of Spillover Effects.” Journal of Labor Economics 39, no. 52 (May 2021): S369–S412.

Fredrickson, Leif, Christopher Sellers, Lindsey Dillon, Jennifer Liss Ohayon, Nicholas Shapiro, Marianne Sullivan, Stephen Bocking, Phil Brown, Vanessa de la Rosa, Jill Harrison, Sara Johns, Katherine Kulik, Rebecca Lave, Michelle Murphy, Liza Piper, Lauren Richter, and Sara Wylie. 2018. “History of US Presidential Assaults on Modern Environmental Health Protection.” American Journal of Public Health, vol. 108 (supplement 2): S95–S103.

Furman, Jason, and Lawrence Summers. 2020. “A Reconsideration of Fiscal Policy in an Era of Low Interest Rates.” Brookings Institution Discussion Paper, November 30, 2020.

Greenspan, Alan. 2001. “Outlook for the Federal Budget and Implications for Fiscal Policy.” Testimony before the Committee on the Budget, U.S. Senate, January 25, 2001.

McNicholas, Celine, Margaret Poydock, Julia Wolfe, Ben Zipperer, Gordon Lafer, and Lola Loustaunau. 2019. Unlawful: U.S. Employers Are Charged with Violating Federal Law in 41.5% of All Union Election Campaigns. Economic Policy Institute, December 2019.

Sojourner, Aaron, and José Pacas. 2018. “The Relationship Between Union Membership and Net Fiscal Impact.” IZA Institute of Labor Economics Discussion Paper no. 11310, January 2018.

Zipperer, Ben, David Cooper, and Josh Bivens. 2021. A $15 Minimum Wage Would Have Direct and Significant Fiscal Effects. Economic Policy Institute, February 2021.

• Inflation is already normalizing rapidly in the U.S.—a recession is not needed to move it down faster than it is already receding, and hence there is no need to tolerate a recession for longer than normal in the name of normalizing inflation.
• Recessions reliably put downward pressure on inflation and nominal wage growth. Given today’s trajectory of inflation and wage growth, and given the normal downward pressure recessions put on these, any recession will end with the Fed’s inflation target very close to being met regardless of the policy response.
• Even before the COVID-19 recession, there were persuasive arguments that the Federal Reserve’s 2% inflation target was too low. If this is true, it is obviously not necessary to tolerate a recession for longer than normal to get all the way back down to 2%.
• Some claim that the “Volcker shock” of the 1970s and early 1980s showed the benefit of not providing stimulus in the face of a steep recession as it was this steadfastness in tolerating high unemployment that broke the inflation of the 1970s. Much of this is wrong—but most fundamentally, Paul Volcker’s Fed reduced interest rates significantly when an actual recession hit.
• In 2008, a shock to oil prices pushed up inflation modestly even while the U.S. economy was in the beginning of what would turn out to be a fierce recession. This modest inflation shock delayed strong actions from the Fed, making the subsequent recession worse.
• Finally, this debate reinforces how important strong automatic stabilizers are for the economy—and the U.S. currently lacks these. Automatic stabilizers would pull much of the debate about the appropriate response to any given recession out of a polarized political realm and would instead respond simply based on hard economic metrics.

Below, I provide more background on why these observations are true and should guide policymakers.

The economics of recessions and what it means for policy

Contrary to what many think, economics has provided a near certain remedy for ending recessions: using the tools of monetary and fiscal policy to boost economywide spending. The main monetary policy tool is lowering interest rates, and the main fiscal policy tools are transfers of resources to spending-constrained households and the direct expansion of public goods and services. There is a long and convincing research literature demonstrating conclusively that such remedies work if applied together and at scale (and that other proposed remedies are either a sideshow or totally ineffective).

When the economy has remained stuck in a recession or a too slow recovery for extended periods, it is because these tools have not been used concurrently or at the proper scale. The clearest example is the decade-long period when the economy operated in a depressed state following the financial crisis and Great Recession of 2008–2009. This period is fully explainable by the failure to use fiscal policy appropriately during that time, with spending austerity throttling growth and job market recovery after 2011.2

The post-2011 fiscal austerity that impeded growth from the Great Recession had clear political roots: Republican policymakers—both at the federal and the state level—thought that the political credit for a rapid recovery would accrue to the benefit of the Obama administration and so actively sought to slow it with spending austerity. This spending austerity was promptly reversed once the Trump administration took power.3

Inflation is no excuse to meet the next recession with austerity

Given the divided government after the 2022 midterm elections, the prospect of the Republican House majority blocking needed recovery efforts if a recession occurs in 2023 or 2024 seems likely. In the earlier episode after 2011, Republican austerity was enforced by gamesmanship over the debt ceiling, and the rationale for this austerity used vague appeals to fiscal responsibility.

The debt ceiling remains a troubling potential tool that could be used to enforce spending austerity in coming years. But another problem is that the rationale for austerity—the need to enforce fiscal discipline—will likely receive undue respect in much economic reporting and commentary. The burst of inflation in 2021 and 2022 has often been blamed on overly generous fiscal relief in response to the COVID-19 recession. Further, it is often claimed that getting inflation back to the Federal Reserve’s 2% inflation target is the policy goal that must trump all others. If one believed both of these claims, the argument for not fighting the next recession with aggressive fiscal aid if the recession starts with inflation at elevated levels might make some sense.

But neither of these claims is true. The inflation of the past two years is not the result of excessive fiscal stimulus—it is instead the result of enormous global economic shocks (pandemic and war) hitting the U.S. economy and causing large (but steadily dampening) ripples. Further, whenever recession does hit, it will put ferocious downward pressure on all sources of inflation. Whatever inflation is when the next recession starts, it will be very close to—or even below—the Fed’s target when the recession ends, even if we appropriately fight the recession with monetary and fiscal policy.5

Recessions almost always occur when economywide spending by households, businesses, and governments (aggregate demand, in the jargon of economists) falls short of the economy’s productive capacity. This productive capacity (sometimes called potential output) is a measure of the value of goods and services that could be produced in the economy if all productive resources were fully employed. The most important of these productive resources is, of course, labor. Thus, the economy’s potential output can be reached only when unemployment is very low. Other productive resources include the economy’s capital stock—factories, equipment, and real estate needed for businesses or the public sector to produce goods and services.

If aggregate demand is weak, there are too few customers (including of public goods) to justify using all available resources in production (because some of the output produced would go unsold). The answer to this imbalance of aggregate demand and potential output is simple—cut interest rates to encourage more spending and less saving, and use the power of the federal government to run deficits to finance direct transfers to low- and middle-income families (the ones most likely to translate these increased resources into new spending right away) and to directly provide more public goods and services (for example, pull forward infrastructure investments).

This recommendation does not really ever change depending on the state of inflation, and it certainly does not change for the U.S. economy of 2023. For one, recessions put completely predictable downward pressure on inflation. For example, since the 1960s, price inflation has fallen 1.8% on average between the beginning and end of recessions, while nominal wage growth has fallen 1.6% on average.6 Given the consistent normalization of inflation and nominal wage growth that already occurred in the second half of 2022, a price and wage deceleration of these amounts would be fully sufficient to quickly return the economy to growth rates consistent with the Fed’s 2% price inflation target. We do not need a recession to restore inflation to normal, and a recession should not be allowed to linger in the name of fighting inflation.

Theoretically, one could imagine entering a recession with inflation far above the Fed’s 2% target (say 6%) and exiting the recessionary period (if it is very short) with inflation still higher than this (say 4%). The first thing to note about this hypothetical is that if inflation is thought to be too high at both the beginning and the end of a recession, then inflation almost by definition is not being driven simply by excess demand (as recessions are evidence of deficient demand). Given this, imposing a “cure” (allowing a recession to grind on) that utilizes aggregate demand restraint is not a direct solution.

In the 1970s, there was much talk of this kind of inertial inflation, in which too high inflation persists through recessions. It is true that inertial inflation can be broken by a long and steep recession. But making this an intentional policy goal would impose far too large a collateral cost relative to the benefit of doing this.8 Bringing down inertial inflation (which again, is not the type afflicting the United States today) should be done with gradual tools that don’t require mass unemployment. Further, even before the COVID-19 shock there was a convincing case to be made that the Fed’s 2% inflation target was too low.9 The benefit of returning the economy to this potentially excessively low target certainly cannot be worth extending a recession.

Even Paul Volcker pivoted and slashed interest rates when outright recession hit

The inflation of the late 1960s and 1970s was reduced significantly in the early 1980s by a long and extremely costly recession. (Unemployment rates peaked at just under 11% in 1982.) This recession was largely caused by the Federal Reserve—then led by Chair Paul Volcker—raising interest rates to just under 20%. This so-called Volcker shock is often interpreted as Volcker steadfastly refusing to relent on raising interest rates even as recession hit. It is clearly true that interest rates were historically high (and likely inappropriately so—though that’s another debate) for much of the recession and recovery period. But it’s not true at all to say that Volcker did not cut rates as recession struck. In fact, as Figure A shows, the Fed cut interest rates rapidly and sharply as the unemployment rate rose.

Figure A

Further, this easing of monetary policy occurred even as fiscal policy pivoted to being extremely expansionary in the recession and early recovery. Figure B (reproduced from Bivens 2016) shows that real per capita public spending grew far more rapidly following the 1980s recession than in any recession since.

Figure B

In short, it is untrue to suggest that the early 1980s “Volcker shock” showed the benefits of keeping macroeconomic policy contractionary even in the face of outright recession. Instead, both monetary and fiscal policy were made far more stimulative as recession hit. There is no historical episode proving the benefits of failing to fight recessions in order to fight inflation.

Even small delays in implementing anti-recession policy can hurt

In 2008, as the economy was clearly already in a recession (which had been modest up to that point but would turn out to be devastating), oil prices surged due to global factors. This high oil price inflation became a big political issue and led the Fed to delay its full recession-fighting actions. At a Federal Open Market Committee (FOMC) meeting in September 2008—just one month before the collapse of Lehman Brothers kicked recessionary job losses into a much higher gear—the Fed decided against implementing further monetary stimulus. Transcripts of the meeting have subsequently shown that this decision was largely due to worry about the oil price shock: Participants in the meeting seemed more concerned with inflation as the greatest imminent danger to the economy. History decided very quickly which side of that debate was right, and less than a month later the FOMC called an emergency meeting to undertake expansionary policy moves.

This was not an instance of the Fed intentionally tolerating a longer or worse recession per se. It was mostly poor judgement about whether the monetary stimulus the Fed had already undertaken (along with the modest fiscal stimulus that had already occurred) would be sufficient to end the recession. But intentions aside, this example shows that when inflationary fears are used to delay or water down recession-fighting efforts, there are severe consequences.

Automatic stabilizers would shield this debate from partisan politics

This danger that some policymakers might opportunistically use the higher inflation of the past year to block needed fiscal stimulus during the next recession highlights again that a more robust system of automatic stabilizers should be a key priority. Automatic stabilizers are programs that put more resources into the economy when it slows on a formulaic basis and without the need for ad hoc legislation. Examples are unemployment insurance, food stamps, Medicaid, and progressive income taxes.

However, in the U.S. automatic stabilizers are far too weak. In the recovery after the Great Recession, this was a problem because policymakers cut off fiscal aid more quickly than a strong system of conditions-based automatic stabilizers would have.12 For those worried about the potential inflationary effects of large fiscal aid packages passed in 2021, automatic stabilizers that ramped down as the unemployment rate hit conditions-based targets earlier than expected could have perhaps allayed their fears.

Regardless of whether one thinks that the primary problem of fiscal aid in recent decades is that it has been inappropriately long-lived or inappropriately stingy (I certainly weigh in on the “too stingy” side), this dispute could be solved to everybody’s satisfaction if automatic stabilizers were more robust. The fact that partisan political positioning becomes a key concern every time the proper scope of fiscal relief following a recession needs to be determined is a big problem for the U.S. economy.

Notes

1. For relatively recent review of effectiveness of fiscal policy, see Wilson 2020. For evidence on monetary policy effectiveness, see Blinder and Zandi 2010. There is lots of evidence that monetary policy is asymmetric—it’s much stronger in a contractionary phase than an expansionary phase. There is also evidence that monetary policy gets less and less effective the closer to zero interest rates get. Nevertheless, if one wants more aggregate demand and the only tool available is interest rates, they should be moved lower.

2. For evidence on this, see Bivens 2016.

3. For evidence on this, see Bivens 2018.

4. See Banerjee and Bivens 2022.

5. On the disinflationary effect of recessions and higher unemployment, see Blanchard, Cerutti, and Summers 2015. While this paper mostly emphasizes a reduction in the responsiveness of inflation to unemployment over time, the estimates still indicate that higher unemployment is associated with lower inflation. Further, the previous time periods when the relationship between unemployment and inflation was stronger saw inflation rates much closer to today’s rate. There is a lot of reason to think that the responsiveness of inflation to unemployment is substantially stronger when inflation starts at a higher pace.

6. Author’s calculations based on Federal Reserve Bank of St. Louis data n.d.

7. See Bivens 2022 on this consistent normalization.

8. On the different types of inflation—including inertial—see Tobin 1974.

9. On the Fed’s 2% inflation target being too low, see Bivens 2017.

10. Many accounts highlight the damaging role that excess unemployment played in harming wage growth for typical workers after 1979 (see, for example, Bivens and Mishel 2021). But the excess unemployment (i.e., unemployment that could have reliably been avoided with different Federal Reserve policy) in the 1979–2007 period occurred mostly during the recovery and expansionary phase of the business cycle, not during the recession. During recessions, the Fed has traditionally tried reasonably hard to engineer lower unemployment. But during recoveries, it has unnecessarily kept interest rates (and hence often unemployment) higher than they need to be to keep inflation in check. In short, the real damage of too-austere monetary policy was that it cut recoveries and expansions short.

11. See Appelbaum 2014 on how the Fed misread this moment in 2008.

12. For steps to improve the unemployment insurance system, see Bivens et al. 2021.

References

Appelbaum, Binyamin. 2014. “Fed Misread Crisis in 2008, Records Show.” New York Times, February 21, 2014.

Banerjee, Asha, and Josh Bivens. 2022. “Lessons from the Inflation of 2021-202(?).” Working Paper presented at Political Economic Research Institute Conference, December 2, 2022.

Bivens, Josh. 2016. Why Is Recovery Taking So Long—And Who’s to Blame? Economic Policy Institute, August 2016.

Bivens, Josh. 2017. Is 2% Too Low? Rethinking the Fed’s Arbitrary 2% Inflation Target to Avoid Another Great Recession. Economic Policy Institute, June 2017.

Bivens, Josh. 2018. “The ‘Boom’ of 2018 Tells Us That Fiscal Stimulus Works, but That the GOP Has Only Used It When It Helps Their Reelection, Not When It Helps Typical Families.” Working Economics Blog (Economic Policy Institute), October 26, 2018.

Bivens, Josh. 2022. “Recent Data Indicate That a ‘Soft Landing’ Is Still in Reach—the Fed Should Try to Secure It: Ignoring Disinflation Signs Heightens Risk of Recession.” Working Economics Blog (Economic Policy Institute), October 31, 2022. 

Bivens, Josh, Melissa Boteach, Rachel Deutsch, Francisco Díez, Rebecca Dixon, Brian Galle, Alix Gould-Werth, Nicole Marquez, Lily Roberts, Heidi Shierholz, and William Spriggs. 2021. Reforming Unemployment Insurance: Stabilizing a System in Crisis and Laying the Foundation for Equity. Center for American Progress, Center for Popular Democracy, Economic Policy Institute, Groundwork Collaborative, National Employment Law Project, National Women’s Law Center, and Washington Center for Equitable Growth, June 2021.

Bivens, Josh, and Lawrence Mishel. 2021. Identifying the Policy Levers Generating Wage Suppression and Wage Inequality. Economic Policy Institute, May 2021.

Blanchard, Olivier, Eugenio Cerutti, and Lawrence Summers. 2015. “Inflation and Activity—Two Explorations and Their Monetary Policy Implications.” International Monetary Fund Working Paper no. 15/230, November 2015.

Blinder, Alan S., and Mark Zandi. 2010. “How the Great Recession Was Brought to an End.” Working Paper, July 27, 2010. 

Bureau of Economic Analysis (BEA). n.d. “National Data: National Income and Product Accounts” (data series). Accessed December 2022.

Federal Reserve Bank of St. Louis. n.d. “Federal Reserve Economic Data (FRED)” (database). Accessed December 2022.

Tobin, James. 1974. “There Are Three Types of Inflation.” New York Times, September 6, 1974.

Wilson, Daniel J. 2020. “The COVID-19 Fiscal Multiplier: Lessons from the Great Recession.” Federal Reserve Bank of San Francisco Economic Letter, May 6, 2020.

From: Robert E. Scott (Economic Policy Institute)

Submitted via email to transition team

For the U.S. economy to “Build Back Better” after the COVID-19 pandemic, the Biden-Harris administration must emphasize job creation in America’s manufacturing and construction sectors. Rebuilding U.S. manufacturing industries, and upgrading domestic infrastructure, can generate millions of high-wage jobs and reduce income inequality while also addressing racial injustice.

There are three key efforts needed to rebuild manufacturing and the U.S. economy:

1. Realign the U.S. dollar and address overseas currency manipulation.
2. Invest in infrastructure and renewable energy.
3. Rebalance U.S. trade.

PRIORITY ONE: Realign the dollar through a competitive currency policy

The single most effective tool for rebalancing trade is the adoption of a competitive dollar policy. The real value of the U.S. dollar—which has gained nearly 21% since mid-2014 alone—needs to fall by 25% to 30% in order to rebalance trade, according recent research.1 Dollar realignment would stimulate rapid export growth, resulting in surging domestic investment and job creation even as it also reduced import growth.

However, there are two reasons the dollar is currently overvalued.

The first is currency manipulation, which is the result of years of foreign central bank purchases of U.S. dollar assets. This has driven up demand for the dollar and helped to keep it overvalued. This currency manipulation can be addressed through government sanctions and intervention.

More recently, however, the extent of currency manipulation has decreased. Instead, during the last five years, excess private demand for U.S. assets from overseas investors has caused the dollar’s value to soar. This second reason, currency misalignment, can be addressed through market interventions.

Implementing a competitive dollar policy will stimulate rapid export growth, resulting in surging domestic investment and job creation, while limiting import growth. Eliminating America’s $864 billion annual goods trade deficit could create between 3.5 million and 6.6 million jobs over the next four years, including at least 1.4 million good manufacturing jobs.

Immediate steps for the new administration

• The next Treasury report on Foreign Exchange Policies of major trading partners (due April 2021) should label all countries meeting the criteria identified by Christopher Collins and Joseph Gagnon of the Peterson Institute for International Economics (PIIE) as currency manipulators. In addition, countries maintaining very large stocks of foreign exchange reserves—which also have a depressive effect on the values of their respective currencies—should also be labeled as currency manipulators (as explained by Dean Baker, senior economist with the Center for Economic and Policy Research). This includes China and Japan.
• In January, the president should immediately announce the suspension of tax waivers on foreign government holdings of U.S. financial assets in the United States, as proposed regarding China by PIIE’s Joseph Gagnon and Gary Hufbauer in 2011. This will also discourage foreign government holdings of U.S. assets and put downward pressure on the dollar. The U.S. should also deliver notice of canceling tax treaties with selected foreign governments. Taxes should then be withheld on income earned on Treasurys and other government assets, at an initial tax rate of roughly 30%. Significantly, other countries that should be subject to this taxation continue to hold huge foreign exchange reserves, most in dollar assets. These countries include China ($3.1 trillion), Japan ($1.4 trillion), Singapore ($500 billion), and South Korea, ($400 billion).
• The president should use his executive authority under the International Emergency Economic Powers Act (IEEPA) to impose a tax on foreign government owned or controlled holdings of U.S. financial assets as soon as possible. Announcing his intent to do so when canceling tax treaties would put currency manipulators on notice that the United States is serious about stopping such practices. The net of these taxes could be widened as needed, since many currency manipulators have stashed large amounts of their reserves in additional Sovereign Wealth Funds, including China ($1.4 trillion), and Singapore ($900 billion).2
• Taxation of foreign government holdings of U.S. assets would discourage currency manipulation. However, government demand for these assets may not be influenced by taxes on the income the assets earned. Therefore, the Commerce Department and the U.S. trade representative should continue to pursue currency countervailing duty (CVD) cases against individual products and countries. Such cases send a “shot across the bow” to currency manipulators in the absence of more comprehensive measures.
• The Biden administration should initiate offsetting purchases of the foreign assets of those countries found to be engaging in currency manipulation, purchases known as countervailing currency intervention (CCI). Overall, such purchases are the most effective tool available to remedy currency manipulation. The use of Exchange Stabilization Fund (ESF) assets by the Treasury and the Federal Reserve to engage in CCI was proposed by Bergsten and Gagnon in 2017. Substantial increases in ESF assets are required to engage in significant CCI intervention, and will require congressional authorization.
• The Biden administration must also address market-driven currency misalignment. It should do so by empowering the Federal Reserve to establish an exchange rate management policy designed to achieve and maintain balanced trade. This can be done by working with Congress to implement the bipartisan legislation proposed by Senators Tammy Baldwin and Josh Hawley in their “Competitive Dollar for Jobs and Prosperity Act” (S. 2357). The measure would impose a “Market Access Charge” on new foreign investor purchases of U.S. assets. It would also authorize a substantial increase in resources for the Treasury Exchange Stabilization Fund, needed to fight government-backed currency manipulation.
• Along these lines, the administration should also impose an initial emergency access charge, exactly as defined in S. 2357, under the IEEPA.

PRIORITY TWO: Rebuild U.S. infrastructure and begin the clean energy transition

The Biden-Harris plan for investments in infrastructure and climate programs, with a full “Buy America” commitment, can supercharge recovery for the U.S. economy. A $2 trillion, four-year plan of investments in these sectors, along the lines of that announced by President-elect Biden in July, would support between 3.4 million and 6.3 million total jobs. Nearly half (45.7%) of the 3.4 million direct and indirect jobs supported would be in good-paying manufacturing and construction sectors.

Immediate steps for the new administration and Congress

• Immediately revive and expand plans for the Moving Forward Act (MFA), an infrastructure bill that was developed by the House Transportation and Infrastructure Committee, and passed by the House on July 1, 2020.
• Develop an expanded plan for renewal of transportation infrastructure legislation, which can attract bipartisan support. To the extent possible, extensions to the MFA should incorporate Biden-plan goals for expanded U.S. auto production, investments in zero-emission public transit, building and housing investments, and research and development.
• Maximize employment and economic impacts as part of the recovery plan by ensuring that the MFA is entirely debt-financed until the economy has fully recovered (with the exception of current revenues in the transportation trust fund).
• Do not raise additional revenues to fund infrastructure investments until and unless we meet two criteria: estimates of total nonfarm employment exceed 152.5 million (the level reached in February 2020) and interest rates on short-term treasury securities exceed 3.5% on a sustained basis. Where possible, user fees should be relied on to fund public investments in infrastructure, as growing reliance on efficient and clean transportation sources will erode transport fuel tax receipts over time.
• To the extent possible, use the infrastructure bill to fund climate-friendly public investment (e.g., electrical grid upgrades, battery development/capacity, R&D for smart grids, etc.).
• Develop separate legislation to support popular incentives:, such as incentives for hybrid cars, e-cars, wind turbines, and solar power to help utilities meet state renewable guidelines; residential and commercial incentives for weatherization; incentives for appliance efficiency upgrades; consumer solar; renewable conversions for schools and public buildings; and, investments in innovation, agriculture, and conservation.

PRIORITY 3: Pursue trade and industrial policies that will rebalance U.S. trade

More than three decades of globalization have devastated U.S. manufacturing and the American working class. Trade-related job losses are just the tip of the iceberg. Globalization has also reduced median wages by roughly $2,000 per year for roughly 100 million working-class Americans. Joe Biden recognized these problems when he promised the United Steelworkers in May that he would not consider any new trade agreements “until we’ve made major investments here at home, in our workers and our communities.”

Immediate steps for the next administration and Congress

• Establish a freeze on negotiating new trade agreements until the dollar is realigned and the U.S. goods trade deficit has been erased.
• Ensure that trade policy does not privilege corporate interests over workers. The proliferation of Investor State Dispute Settlement (ISDS) clauses inserted into international trade and investment agreements has created a global system of special courts exempt from any judicial appeal or review. These courts allow multinational companies to sue governments for any potential infringement on future profits, as documented by Todd Tucker in his book Judge Knot. These agreements have cast a pall over the ability of governments to regulate in their own legal and national interest. The U.S. must negotiate the elimination of ISDS clauses from most or all trade deals.
• Promote welfare-enhancing multilateral agreements negotiated by the USTR in areas such as labor rights and environmental standards while also rejoining the Paris Climate Accord.
• Pursue multilateral rules to address major international challenges, such as greenhouse gas (GHG) emissions. The U.S. should pursue binding agreements to reduce GHG emissions, especially with China—the world’s largest and most rapidly growing GHG emitter—earlier than called for in the current Paris Climate Accord.
• Ensure that the USTR works with the Commerce Department to aggressively combat overcapacity in steel, glass, paper, solar panels, and a host of other industries distorted by massive state subsidies and other illegal trade and industrial policies.
• Maintain Section 232 steel and aluminum tariffs until tariffs can be replaced by more comprehensive, global limits on unfair trade in these products. One model is to negotiate global tariff agreements to “wall off” products from countries with excess capacity. At present, overcapacity is widespread in many exporting countries, including Japan, Korea, Brazil, Turkey, and China.
• Eliminate tax evasion, corporate inversions, and tax havens that allow multinational enterprises to avoid corporate taxation. The Tax Cuts and Jobs Act of 2017 (TCJA) established new, lower tax rates for foreign investment by multinational corporations; this encouraged further offshoring. Consider adopting sales factor apportionment (SFA) to fully tax profits on all corporate sales in the United States, regardless of where production takes place or where corporations are domiciled. SFA techniques have been used for many years by states to fairly allocate taxation of corporate profits.
• Don’t tax U.S. consumers to protect the intellectual property rights of U.S. multinationals in China. This simply encourages more offshoring of U.S. jobs and factories. As Dean Baker has explained, stronger patent and copyright protections have transferred roughly $1 trillion annually from workers and consumers to corporations and the richest 10 percent.
• Strengthen “Buy America” requirements for all federal, state, and local purchases, as supported by the Alliance for American Manufacturing’s industrial policy proposals. Buy America requirements can greatly enhance the job creation and domestic output of public investments. Historically, Buy America preferences have been loosely enforced.
• Develop new standards and methods to maximize domestic job creation associated with any recovery act, clean energy, or infrastructure expenditures. One simple step would be to require bidders for large government contracts to submit job impact assessments, and to document these outcomes in post-project assessments.
• Establish a strong, whole-of-government program to reshore critical materials production. This includes bringing back to the United States the production of everything from pharmaceuticals to medical equipment to rare earth metals.
• Expand job training and workforce development programs, and consider adopting “flexicurity”-style programs—modeled after those developed in Denmark and other European countries—to support growth and renewal of America’s aging industrial workforce.
• Revamp America’s unemployment insurance (UI) system. Effective UI systems are industrial policies. Jobs not destroyed are much cheaper to restart than those that have been entirely eliminated through short-sighted labor policies. The COVID-19 crisis has demonstrated that America’s UI system is broken and in desperate need of repair. In contrast, many European governments have paid firms to keep workers on the payroll, so that when employers emerge from a downturn, they would be intact.
• Greatly expand R&D and Cooperative Extension Services. Fund the proposal by Simon Johnson and Jonathan Gruber in their book Jump Starting America to identify metropolitan areas that could be hubs of science and technology. Designate them to receive large-scale science and tech spending using the tripartite federal/state and local/private sector investment model to create dozens of national centers of manufacturing research and excellence. In addition, the Hollings Manufacturing Extension Partnerships, which have been targeted for extinction in the Trump administration, should be substantially expanded.
• Substantially increase domestic content requirements and require jobs impact statements by the US Export-Import Bank in its Buy America policies, which have been watered down beyond all recognition. These standards must be tightened and reformed.
• Reevaluate the costs and benefits of foreign direct investment in the United States. So-called “insourcing” (foreign investment in the United States) is dominated by foreign acquisition of U.S. companies, such as Lenovo’s purchase of IBM’s PC division in 2005. Such purchases have eliminated millions of U.S. jobs over the past three decades through layoffs, plant closures, and sell-offs. Furthermore, foreign multinational companies (MNCs) often buy domestic firms simply to distribute their own exported products. As a result, foreign MNCs are responsible for a large and growing share of U.S. trade deficits. Adding insult to injury, state and local governments are often involved in a race to the bottom for such investments, competing to offer tax abatements and infrastructure subsidies to attract foreign investors. The United States should consider banning tax abatements and infrastructure and other subsidies to foreign investors unless entities seeking subsidies can prove that they are effectively creating jobs.

Endnotes

1. Fred Bergsten, “Time for a Plaza-II?” in International Monetary Cooperation: Lessons from the Plaza Accord after Thirty Years, eds. (Washington, D.C.: Peterson Institute for International Economics, 2016), Table 14-5. Bergsten estimated that in order to rebalance U.S. trade, the real value of the U.S. dollar must fall by 26.5% on a trade-weighted basis against the currencies of major surplus countries, including the Euro Area countries, China, and Japan. In their 2020 working paper for the Coalition for a Prosperous America (“Modeling the Effect of the Market Access Charge on Exchange Rates, Interest Rates and the U.S. Economy”), Steven Byers and Jeff Ferry, using a macroeconomic model from the Federal Reserve, estimated that the dollar needs to fall by 27% to rebalance U.S. trade.

2. These funds include China Investment Corporation ($1.046 trillion) and the National Council Social Security Fund ($324 billion), and from Singapore, GIC Private Limited ($453 billion) and Temasek Holdings ($417 billion) according to the Sovereign Wealth Fund Institute (data downloaded from SWFI November 22, 2020).

This policy memo focuses on one major economic argument in favor of increased infrastructure investment—that it would increase demand for American manufactured goods and, in turn, generate American manufacturing jobs. As this memo shows, more jobs will be created if policymakers take steps to reduce the yawning U.S. trade deficit that allows jobs to “leak” outside the U.S. economy as U.S. spending increases.

Spending in any given economic sector sets off ripple effects, or linkages, across other sectors.2 For example, an increase in demand for construction-sector output supports construction jobs directly but also supports jobs in industries that supply inputs to the construction sector. Take the case of a large infrastructure project that includes constructing intercity rail transportation. Such a project would create direct jobs in construction (jobs building tunnels and bridges and track beds, and the like). But the project would also create indirect jobs in the industries supplying the wide range of inputs required—such as construction equipment and tools, steel and concrete, and services rendered by environmental and information technology consultants.

The number of direct and indirect jobs supported by an increase in economywide spending depends in part on how much of this spending goes to purchase imports rather than domestically produced goods and services. In the case of infrastructure investments specifically, the number of U.S. manufacturing jobs supported depends on the share of purchased manufacturing inputs that is produced domestically as opposed to being imported from abroad.

The larger the share of imported inputs, the smaller the number of supplier jobs supported in domestic manufacturing. This policy memo provides an illustrative example of how many manufacturing jobs would be supported under the status quo (i.e., if the import share remains high due to the current large trade deficit) and under an alternative scenario in which the share of manufacturing inputs imported from abroad drops by a third due to a sizable decrease in the manufacturing trade deficit.

We find that by cutting the manufacturing trade deficit to a more sustainable level (by roughly two-thirds), tens of thousands of additional U.S. manufacturing jobs would be supported by any ambitious investment in infrastructure. There are many reasons why we should use the levers of policy to put American manufacturing production on a more-level playing field with global competitors. These policy levers—whether they are moves to ensure that the value of the U.S. dollar falls to a more competitive level in global markets, to stringently enforce trade laws, or to enact “Buy America” provisions that mandate some level of domestic content in government procurement—can help maximize the job creation spurred by infrastructure investment in communities across the country.

Background on infrastructure investments and trade shares in manufacturing

Currently, federal government financing supports roughly $350 billion per year in U.S. transportation and water infrastructure, either directly or through transfer of fiscal resources (grants or loan guarantees or tax exemptions) to state and local governments.3 It has been widely argued that this is insufficient and that a much larger infrastructure investment effort should be pursued.4 This policy memo considers the employment impact of a $150 billion increase in infrastructure investment that would raise annual infrastructure spending up to $500 billion.

A commonly used proxy for manufacturing trade flows includes goods imports and exports, but excludes agricultural goods from exports and excludes petroleum products from imports.5 Figure A shows manufacturing exports and imports as a share of total U.S. gross domestic product (GDP). The gap between imports and exports is the trade deficit in manufacturing goods expressed as a share of GDP. What stands out from this figure is the large trade deficit in American manufacturing.

Figure A

While the trade deficit in manufactured goods is substantial when expressed as a share of overall GDP, it is much bigger when expressed as the share of domestic consumption of manufactured goods. Domestic consumption is measured as domestic production in manufacturing plus imports of manufactured goods minus exports of manufactured goods. If trade were balanced, then domestic consumption would equal domestic production. When instead the U.S. runs a manufacturing trade deficit, this means that domestic production falls short of domestic consumption and hence manufacturing employment is depressed, even as Americans consume evermore manufactured goods.

The manufacturing trade deficit is roughly 14 percent of domestic manufacturing consumption when this consumption is measured in gross output terms. If consumption is measured in value-added terms, then the manufacturing trade deficit is closer to 38 percent. Because it is not entirely clear which is the more relevant measure for assessing the trade deficit’s impact on American manufacturing, we simply take the average of these measures—26 percent.6 This is a very large effect—domestic manufacturing production would be a quarter larger in the United States if manufacturing trade were balanced.

The trade deficit and the enormous share of domestically consumed manufactured goods that are imported are not the inevitable result of a globalized economy. Instead, they are largely the outcomes of a host of long-term policies that have hamstrung domestic manufacturing production. Policies have encouraged businesses to chase low-wage workforces to foreign nations comparatively unencumbered by regulatory protections for workers’ rights or the environment, while policymakers have failed to enforce our trade and procurement laws and have been reluctant to acknowledge and address currency misalignments—even those caused by other nations’ intentional deployment of mercantilist exchange rate management.7 These past policy failures have not just led to rampant job loss in the manufacturing sector in recent decades; they have also weakened the power of infrastructure investment to create jobs. In short, because of our trade deficit, future policy efforts—such as U.S. taxpayer-funded infrastructure investments—that would otherwise be a boon to American manufacturing may instead lead to the leakage of manufacturing jobs abroad.

Two potential infrastructure scenarios

As we note above, if an ambitious infrastructure investment plan is approved by policymakers, the United States could be spending upward of $500 billion per year on these investments. One natural question that might arise is, “How much would this infrastructure investment buoy demand for jobs in American manufacturing?” Figure B provides estimates for two scenarios.

Figure B

Scenario One is the status quo, reflecting our estimate of manufacturing jobs that would be supported through $500 billion in infrastructure spending given today’s import shares in manufacturing industries. This estimate is obtained directly from the domestic employment requirements matrix (DERM) maintained by the Bureau of Labor Statistics (BLS 2017). The DERM allows one to feed in a vector of spending in infrastructure construction activity and derive the jobs that would be supported in supplier industries, including manufacturing.

Scenario Two is an estimate of manufacturing jobs that would be supported through $500 billion in infrastructure spending if import shares of manufacturing consumption were cut by a third. We choose this share because it is roughly consistent with a 70 percent reduction in the manufacturing trade deficit, with imports and exports contributing proportionally to this closure.8 Given that manufacturing trade deficits will have to substantially shrink in coming decades if overall U.S. trade is going to move closer to a balance, it makes sense to assess what a significant reduction in the overall manufacturing trade deficit implies for import shares of manufacturing consumption.9

Under Scenario One, a $500 billion infrastructure investment yields 340,900 jobs in the manufacturing sector. Under Scenario Two, with import shares cut by a third, a $500 billion infrastructure investment yields 384,600 jobs in manufacturing, or almost 45,000 more jobs than would be supported by infrastructure investments alone.

Appendix Table 1 provides the breakdown of manufacturing industry employment gains stemming from these two scenarios. In either scenario, the 10 largest-gaining industries are architectural and structural metals manufacturing; cement and concrete product manufacturing; other wood product manufacturing; plastics product manufacturing; machine shops manufacturing; veneer, plywood, and engineered wood product manufacturing; other fabricated metal product manufacturing; sawmills and wood preservation; lime, gypsum, and other nonmetallic mineral product manufacturing; and ventilation, heating, air-conditioning, and commercial refrigeration equipment manufacturing.

Discussion of results

There are, of course, a number of tools available for reducing the leakages from excessive net imports (trade deficits) in manufacturing. The most effective ones are systemic; particularly effective are those that target misaligned exchange rates or other persistent unfair trade practices that are the root cause of overall trade deficits.10

In the specific case of jobs supported in American manufacturing by infrastructure investments, more targeted policies mandating domestic content for government procurement and contracting would also boost domestic manufacturing jobs. Such “Buy America” policies ensure that taxpayer-financed projects use goods produced by American companies and workers, providing an economic boon to our manufacturing sector with no additional spending. While existing domestic-content preference policies are of immeasurable importance, it is important to note that they are limited in their scope—in terms of both the types of infrastructure projects and the types of materials that are covered. Meanwhile, many policymakers have proposed changes that would strengthen enforcement and close loopholes to prevent leakage.

The goal of this policy memo is simply to provide an illustrative estimation of the scale of job gains that could possibly be claimed by ensuring that large-scale infrastructure investments are supported by a (reasonably) higher share of domestic content in manufacturing supplier industries. These job gains are far from trivial and would be a major benefit of policies that reduce the gap between imports and exports in America’s manufacturing sector.

Acknowledgments

This research was made possible by support from the Alliance for American Manufacturing.

Appendix Table 1

Endnotes

1. See AAM 2019 for polling results on infrastructure spending.

2. See Bivens 2019 for a description and quantification of these linkages.

3. This estimate comes from the Congressional Budget Office (CBO 2018a, 2018b). The CBO reports indicate that the federal government spends roughly $100 billion directly on infrastructure, and that the federal government supports roughly 60 percent of the $340 billion spent by states indirectly through loan guarantees or tax exemptions. The federal government also provides roughly $50 billion per year in grants to state and local governments for transportation projects. Adding these fiscal resources together, the federal government supports roughly $350 billion in infrastructure investment.

4. See the report card from the American Society of Civil Engineers (ASCE 2017) for the most-cited estimate of the insufficiency of current infrastructure investments.

5. More precise measures of manufacturing trade flows are available, but not on as timely a basis or with as long a historical time series as this proxy measure.

6. Gross output is essentially a measure of sales or revenue of an industry (with intrasectoral purchases removed). Value added is a measure of final output of an industry, with the contribution of all intermediate inputs removed. It is not entirely clear which measure is the more appropriate denominator for scaling the manufacturing trade deficit. For overall trade balances, it is clearly correct to use the value-added measure of output as the denominator in such a calculation, as the total trade deficit is the same whether measured in gross output or value-added terms. But for trade balances of specific sectors in the economy (even large sectors like manufacturing), this strict correspondence between gross output and value-added concepts of trade flows does not necessarily hold. Given this uncertainty, we simply report both measures.

7. See Scott 2017 on how policy decisions regarding exchange rates have been the dominant factor explaining rising trade deficits.

8. We choose a 70 percent reduction in the manufacturing trade deficit because this decline, coupled with unchanged service surpluses, would roughly balance overall trade.

9. As noted earlier, the manufacturing trade deficit is roughly equal to 26 percent of domestic manufacturing consumption. A 70 percent reduction in the U.S. manufacturing trade deficit (given current levels of consumption) would hence require an 18.2 percent increase in domestic production. If we assume 60 percent of this increase comes from reduced import shares (with the remainder coming from expanded exports), this implies a 10.8 percent increase in total domestic manufacturing output for any increase in domestic demand. If employment responded proportionately, this would imply a 10.8 percent increase in the level of manufacturing employment for any given increase in domestic demand. If we apply this job boost to the Scenario One measure of jobs to get the number of jobs supported by a 70 percent decrease in manufacturing trade deficits, this implies over 377,000 jobs supported by a $500 billion infrastructure investment, a number quite close to our measure that simply reduces import shares in domestic manufacturing production by a third.

10. See Scott 2017 for a discussion of the causes of manufacturing trade deficits.

References

Alliance for American Manufacturing (AAM). 2019. “Findings from a National Survey on Infrastructure and Buy American Policies” (presentation).

American Society of Civil Engineers (ASCE). 2017. Infrastructure Report Card.

Bivens, Josh. 2018. The Potential Macroeconomic Benefits from Increasing Infrastructure Investment. Economic Policy Institute, July 2017.

Bivens, Josh. 2019. Updated Employment Multipliers for the U.S. Economy. Economic Policy Institute, January 2019.

Bureau of Economic Analysis (BEA). 2018. National Income and Product Accounts (NIPA) Table 1.1.6. Accessed December 2018.

Bureau of Economic Analysis (BEA). 2019a. “Imports of Nonpetroleum Goods” [A187RC1Q027SBEA], retrieved from FRED, Federal Reserve Bank of St. Louis. Accessed February 12, 2019, at https://fred.stlouisfed.org/series/A187RC1Q027SBEA.

Bureau of Economic Analysis (BEA). 2019b. “Exports of Nonagricultural Goods” [A182RC1Q027SBEA], retrieved from FRED, Federal Reserve Bank of St. Louis. Accessed February 12, 2019, at https://fred.stlouisfed.org/series/A182RC1Q027SBEA.

Bureau of Labor Statistics (BLS). 2017. Employment Requirements Matrix. Last modified October 2017.

Congressional Budget Office (CBO). 2018a. Federal Support for Financing State and Local Transportation and Water Infrastructure. October 2018.

Congressional Budget Office (CBO). 2018b. Public Spending on Water and Transportation Infrastructure 1956‒2017. October 2018.

Scott, Robert. 2017. Growth in U.S.–China Trade Deficit Between 2001 and 2015 Cost 3.4 Million Jobs: Here’s How to Rebalance Trade and Rebuild American Manufacturing. Economic Policy Institute, January 2017.

While any attempt to secure a transformative deal on a new NAFTA will certainly face formidable obstacles, it is nonetheless important to lay out a progressive roadmap for the ongoing talks. Instead of allowing multinational corporations to dominate the agenda, we should instead address the root causes of our ballooning trade deficits, such as currency manipulation and misalignments. We also need to use these high-level talks to end the systematic and egregious repression of workers’ rights that disempowers workers and exacerbates inequality in all three North American countries.

NAFTA renegotiation efforts aiming to put workers first would pursue the priorities listed below. These priorities can be used to judge whether or not the NAFTA renegotiation is being done for multinational corporations or for workers in all three countries.

1. Put labor standards with strong enforcement tools into NAFTA.

NAFTA must include specific provisions protecting workers’ rights and wages, including the right to form unions and bargain collectively, and establish an enforcement body that can penalize those who infringe on those rights, including threats to free and independent labor organizations. NAFTA could mandate that all signatories respect the labor standards identified as fundamental worker rights by the International Labour Organization (ILO). Canada even recently requested ending right-to-work (RTW) laws in U.S. states as part of NAFTA renegotiations because they suppress American wages and threaten Canadian jobs—a potentially game-changing provision to include.

2. Eliminate investor–state dispute settlement (ISDS) provisions.

ISDS provisions create special legal privileges for foreign investors, notably the right to sue host governments in private arbitration tribunals (“corporate courts,” as the AFL-CIO calls them) for failing to meet certain standards that cause the investor economic harm. In practice this means that investors can challenge any law or policy change they claim will cut profits. For example, ISDS provisions have been used by American companies to attack basic, sensible labor and environmental safeguards. ISDS provisions have a chilling effect on regulatory safeguards, infringe on our trading partners’ democratic rights to manage their own domestic economies, and encourage American firms to locate abroad and leave American workers behind, harming jobs and wages in the United States.

3. Revise intellectual property (IP) provisions that inflate prices in areas such as health care.

The current IP provisions in NAFTA have extended private monopolies that generate massive profits for drug, software, entertainment, and other industries. In particular, the high cost of prescription drugs is becoming prohibitive for many working families. NAFTA renegotiations should move toward innovation systems that support technological progress but also reduce costs for families in all three countries, while ensuring fair compensation for artists, writers, and innovators.

4. Revise rules of origin provisions.

Rules of origin, which are the criteria used to define where a product was made, are a critical component of trade agreements because they determine which products can benefit from tariff concessions. Rules of origin should be renegotiated to maximize the benefit to workers, farmers, and firms, and to ensure that NAFTA is not turned into a back door through which products from nonsignatory countries flood the North American market.

5. Eliminate procurement requirements that undermine “Buy American” policies.

If policymakers really want to support the “Buy American” principle, the procurement requirements in Chapter 10 of NAFTA should go. Because they require that foreign bidders have equal access to U.S. government contracts, the current procurement provisions have resulted in the loss of U.S. jobs.

6. Include enforceable currency rules that include penalties for violations.

A NAFTA that helps workers would include enforceable currency rules. Currency manipulation and misalignment are the least understood yet most important causes of manufacturing job loss. Both make U.S.-made products less competitive and increase our trade deficits.

While neither Canada nor Mexico currently engages in active currency manipulation or misalignment, including currency rules with enforcement in a major trade agreement would create a standard that should be incorporated into all present and future trade and investment agreements. For example, this is a major issue to consider in reforms of the U.S.–Korea Free Trade Agreement.

References

AFL-CIO. 2017. A NAFTA That Works Must Empower Working People, Not Corporations. June 12.

Bivens, Josh. 2017a. Adding Insult to Injury: How Bad Policy Decisions Have Amplified Globalization’s Costs for American Workers. Economic Policy Institute, July 11.

Bivens, Josh. 2017b. “A NAFTA Renegotiation Game-Changer, until the Trump Administration Squanders It.” Working Economics (Economic Policy Institute blog), September 7.

Brotherton-Bunch, Elizabeth. 2017. “The Procurement System Puts U.S. Companies at a Disadvantage. Buy America Can Help.” Manufacture This (Alliance for American Manufacturing blog), March 15.

Economic Policy Institute. Various years. Currency Policies. Collection of publications available at epi.org/research/currency-policies.

International Labour Organization. 2010 (1998). ILO Declaration on Fundamental Principles and Rights at Work and Its Follow-Up. Second edition with Annex revised 2010. First published 1998.

Scott, Robert E. 2011. Heading South: U.S.–Mexico Trade and Job Displacement after NAFTA. Economic Policy Institute, May 3.

Scott, Robert E. 2015. Unfair Trade Deals Lower the Wages of U.S. Workers. Economic Policy Institute, March 13.

Scott, Robert E. 2016. Currency Manipulation and Manufacturing Job Loss: Why Negotiating “Great Trade Deals” Is Not the Answer. Economic Policy Institute, July 21.

Scott, Robert E. 2017a. “Comments Regarding Causes of Significant Trade Deficit for 2016.” Testimony before the U.S. Department of Commerce, May 18.

Scott, Robert E. 2017b. Growth in U.S.–China Trade Deficit between 2001 and 2015 Cost 3.4 Million Jobs: Here’s How to Rebalance Trade and Rebuild American Manufacturing. Economic Policy Institute, January 31.

Scott, Robert E. 2017c. “Renegotiating NAFTA Is Putting Lipstick on a Pig.” Working Economics (Economic Policy Institute blog), August 21.

Stiglitz, Joseph E., Dean Baker, and Arjun Jayadev. 2017. “Intellectual Property for the Twenty-First-Century Economy.” Project Syndicate, October 17.

Tucker, Todd. 2015. “The TPP Has a Provision Many Will Love to Hate: ISDS. What Is It, and Why Does It Matter?” Washington Post, October 6.

U.S. Government Accountability Office. 2017. Government Procurement: United States Reported Opening More Opportunities to Foreign Firms Than Other Countries, but Better Data Are Needed. Published February 9. Publicly released March 13.

]]> https://www.epi.org/publication/recommendations-for-states-facing-budget-shortfalls-focus-on-connecticut/ Mon, 08 May 2017 18:03:30 +0000 http://www.epi.org/?post_type=publication&p=122624 Updated May 11, 2017

The first half of each year is state budget season across much of the United States. This policy memo is intended to provide information and evidence to state legislators and governors as they debate the optimal mix of taxes, spending, and investment in their states for the coming year.

We first look at the national economic context within which states must navigate and provide a few key recommendations for making state-level budget decisions within that context. We then examine key indicators for one specific state—Connecticut—to see how its mix of spending and taxes follows or departs from these key recommendations.

Key national findings are:

• A full nine years after the start of the Great Recession, the U.S. economy remains damaged due to a shortfall in spending by households, governments, and businesses (“aggregate demand”) relative to the economy’s productive capacity. This shortfall in demand can be seen in measures of labor market health (such as the share of prime-age adults with a job, or rates of nominal wage growth) that remain far below pre–Great Recession levels.
• The culprit for this slow recovery is easy to identify: spending austerity by governments. If public spending by all levels of government had followed the same trajectory since the end of the Great Recession as the trajectory followed during previous recoveries, the U.S. economy would have reached full employment long ago.
• Crucially for state governments, state and local spending has been the prime driver of this austerity. State and local spending has grown more slowly over the current recovery than over any other previous recovery.
• While states are generally bound by law to balance their budget, the economic impact of spending cuts is more damaging to near-term state economic growth than are tax increases, and spending cuts are far more damaging than progressive tax increases (tax hikes on high-income households or corporations).
• A growing literature highlights the crucial importance of public investment in spurring economy-wide productivity growth over the longer term. Productivity growth (or the income generated in an average hour of work in the economy) provides the ceiling on how fast potential living standards can rise. State and local governments provide the bulk of public investment (including infrastructure) in the U.S. economy. This makes state and local decisions about the level of public investment effort crucial for wider economic performance.
• Fears that raising revenue from high-income households will lead to massive out-of-state migration are hugely overblown and are not supported by the highest-quality and most up-to-date economic research.
• Finally, there is room to increase the revenues that state and local governments collect from the business and corporate sectors without damaging economic growth. Pursuing a strategy of cutting corporate rates to spur growth and cutting spending to finance these cuts is depressingly common. The evidence that corporate rate cuts will appreciably spur growth is weak, and the evidence that cutting spending will damage growth is strong. Closing loopholes in the business tax code can raise revenue from the business sector without raising the rates they face.

Key recommendations for states facing budget shortfalls:

• Favor tax increases, and particularly progressive tax increases, over spending cuts.
• Close loopholes in the business tax code to raise additional revenue from the business sector without raising rates.
• Increase (rather than cutting) spending on public investment, K–12 education, and higher education to spur longer-term economic growth.

Regarding Connecticut, we find that:

• Connecticut spending on public investment and K–12 education per pupil have held up better than national averages, but the state has still cut back on the share of inflation-adjusted resources devoted to these crucial investments since 2000.
• Connecticut ranks 45th among states in state support for higher education, even though it is clear that increased investments in higher education would help the state’s fiscal situation over the long run. The fiscal 2017 budget actually saw a $33.5 million decline in higher education spending (Thomas 2017).
• As a share of gross state product (GSP), capital outlays (or investment) in Connecticut in 2014 were in the lowest fifth of all states.
• Overall, Connecticut taxes as a share of state personal income are lower than the national average, and this share has taken longer to bounce back from the Great Recession than it did from previous economic recessions.
• Connecticut has ample room to raise more revenue from its business sector. Measured as a share of GSP, Connecticut is tied for the most lightly taxed state in the nation. Connecticut also relies less on business taxes for overall revenue than any other state in the nation.
• Raising the top marginal tax rate by just 0.5 percentage points would boost state tax revenues by more than $200 million annually. Increases substantially larger than this would still leave Connecticut’s top tax rate below that of New Jersey and New York.
• Other steeply progressive revenue sources—such as joining a state compact with New York, New Jersey, and Massachusetts to close the carried interest loophole—would similarly raise significant amounts of revenue for Connecticut. Closing the carried interest loophole alone would likely raise $535 million.
• In short, Connecticut has ample room to move further toward a state budget that strengthens public investment and other vital forms of state and local spending and that funds these investments with progressive revenue sources, including more revenue from the business sector.
• If state spending were boosted by $2 billion annually in coming years, this could move the share of the state budget directed toward children close to the 40 percent target highlighted by Connecticut Voices for Children (Thomas 2017) without cutting spending in other areas of the budget. This spending target would also completely undo proposed cuts in the governor’s proposed fiscal year 2018 budget.1
• This level of state spending, if financed by progressive revenue sources, would boost economic output in the state by roughly $2.2 billion and would boost the number of jobs statewide by 150,000 in the coming years.
• This high-investment strategy, financed by progressive revenue sources, would also bring greater long-run stability to the Connecticut budget. This is true because of the long-run beneficial impact on the state fiscal situation stemming from educational investments. It is also due to the stronger state economy that would result from a high-investment strategy with sources of aggregate demand that are more predictable and stable than the consumption decisions of high-income households.
• In the longer run, Connecticut can help to stabilize state spending over the business cycle by broadening the base of the state sales tax (including sales tax collections on Internet sales) and by instituting rules that protect the Budget Reserve Fund from opportunistic tax-cutting during times of relatively prosperity and high tax collections.

The national economic situation

The economic recovery from the Great Recession remains incomplete. While the headline unemployment rate has nearly returned to pre Great Recession levels, broader measures of labor market health like the share of prime-age adults with a job (the employment-to-population ratio, or the “EPOP”) have not, as shown in Figure A.

Figure A

Further, nominal wage growth—the most telling bottom-line indicator of whether or not there remains “slack” in the labor market—has ticked up a bit over the past year but remains far below what it should be in a healthy economy, as shown in Figure B.2 In short, seven-and-a-half years into recovery from the Great Recession, there remains substantial slack in the labor market, and growth has not been fast enough to both work off this slack and absorb new labor market entrants.

Figure B

The culprit for this slow growth is clear: spending austerity at all levels of government. The labor market slack highlighted earlier shows clearly that the economy suffers from a shortfall of aggregate demand (spending by households, businesses, and governments) relative to the economy’s productive capacity. This shortfall of demand has kept resources (including willing workers) idle for much of the past decade. The most conspicuous source of aggregate demand weakness since 2011 has been slow growth in public spending.

This overall public spending austerity has been driven largely by spending of state and local governments.3 Figure C shows the growth in real state and local government spending over the past four recoveries. If the spending of state and local governments following the Great Recession had followed the same trajectory it did after the steep early 1980s recession, state and local governments would be spending $400 billion more today, and full employment would have been reached years ago.

Figure C

State and local spending austerity is a policy choice, not an inevitability

Because the federal government can run deficits for sustained periods with little economic harm, it is less constrained in its ability to sustain or increase spending during periods of economic weakness (including spending on grants to state and local governments). This means that federal policymakers bear more of the blame for the decision to embrace austerity than do their peers in states. However, this should not let state and local governments entirely off the hook. While state governments are generally bound by law to balance annual budgets, they can choose whether or not to do this with tax increases or spending cuts. By and large over the past nine years they have chosen to rely far too heavily on spending cuts.

A 2001 letter co-written by Nobel economist Joseph Stiglitz (Orszag and Stiglitz 2001) puts this clearly:

Basic economy theory suggests that direct spending reductions will generate more adverse consequences for the economy in the short run than either a tax increase or a transfer program reduction. The reason is that some of any tax increase or transfer payment reduction would reduce saving rather than consumption, lessening its impact on the economy in the short run, whereas the full amount of government spending on goods and services would directly reduce consumption.

…The more that the tax increases or transfer reductions are focused on those with lower propensities to consume (that is, on those who spend less and save more of each additional dollar of income), the less damage is done to the weakened economy. Since higher-income families tend to have lower propensities to consume than lower-income families, the least damaging approach in the short run involves tax increases concentrated on higher-income families. Reductions in transfer payments to lower-income families would generally be more harmful to the economy than increases in taxes on higher-income families, since lower-income families are more likely to spend any additional income than higher-income families.

This general argument—that spending cuts weigh down growth more heavily during times of demand weakness than tax increases do—has been buttressed by several studies comparing the “bang for buck” of various tax and spending changes in spurring (or dragging on) economic growth during times when the economy continues to have productive slack.

Bivens (2011) collects a number of estimated “multipliers” of tax and spending changes, and these are reproduced in Table 1. The multiplier measures how much economy-wide output changes in response to a $1 change in either taxes or spending. The multipliers gathered are largely for federal policy changes, but they map directly onto state and local equivalent changes. So, for example, both public and private forecasters estimate that each $1 cut in progressive taxes will boost economic output by $0.30 to $0.40. But each $1 in spending increases in transfers directed toward lower-income households (such as unemployment insurance or Medicaid), government consumption, and government investment will boost economic output by about five times as much—between $1.40 and $1.70.4 This logic also works in reverse: tax increases would drag on economic growth by much less than spending cuts would.

Table 1

Several studies confirm that these macroeconomic multipliers hold even more strongly for measures that change spending at the state level.

Shoag (2013) estimates even larger multipliers specifically for state spending. To make these estimates, he exploits the fact that some states receive positive or negative shocks to spending possibilities by the over- or underperformance of the pension funds they manage. Positive shocks to the returns earned by state pension funds tend to be spent by the state, and the result is a significant increase in state economic activity, on the order of a $2 change in economic activity for every $1 change in state spending.

Chodorow-Reich (2012) look at the effects of the increase in the federal matching payment for Medicaid that was included in the American Recovery and Reinvestment Act (ARRA). Because part of the formula for determining the state-specific size of this increase is unrelated to state economic conditions, it provides an excellent “exogenous shock” that can be correlated with subsequent employment growth to obtain a measure of the causal effect of state spending on economic outcomes. The effects of increases to Medicaid spending are startlingly large, with every $100,000 in additional spending supporting 3.8 jobs, with 3.2 of these jobs being outside the health care sector.

Wilson (2014) similarly looks at another component of state aid from ARRA that was exogenous to state economic conditions—highway grants. He finds that each $125,000 in these highway grants created one job. At first glance, this might sound expensive, but it’s actually a higher job/income ratio than exists economy-wide, making these investments comparatively efficient job-creation policy.

There are long-run benefits to productivity of increased public investment

Besides putting less drag in the near term on economic recovery through their impact on aggregate demand, decisions to resist spending cuts will also pay off in the long term. A growing research literature has in recent years confirmed the high rates of return of public investment. This literature has particularly focused on the benefits of infrastructure investments, which in the United States are predominantly made at the state level (see Bivens [2012] for a review of some of this literature).

Essentially, each $1 in infrastructure investment yields a rate of long-run return in the form of higher private-sector income of between $0.10 and $0.40. These are rates of return substantially higher than what prevails for private-sector investment, indicating that the political process has generally led to underinvestment in public goods in recent decades.

Evidence of this underinvestment also can be found outside of “core” infrastructure investments (“core” investments are those in transportation, utilities, and water management and treatment). Cellini, Ferreira, and Rothstein (2010), using high-quality research methods that allow one to isolate the purely causal effect of investments in school facilities, found that each $1 in additional investment yielded a return of $1.50 in California districts that undertook them. Besides boosting the capitalized value of homes, these school facility investments were also strongly associated with improved student performance.

Across all states, spending on public investments and educational spending have severely lagged over the past business cycle. Figure D shows gross investment by state and local governments in the latest recovery and compares this with previous recoveries.

Figure D

Figure E shows inflation-adjusted state and local spending per public school pupil for K–12 students in recent years. The aftermath of the Great Recession was disastrous for this measure, as per pupil spending fell by 7 percent from 2007 to 2015. Recent years have seen the beginning of recovery, but the level remains substantially below pre–Great Recession peaks.

Figure E

Are there hard constraints on states looking to raise revenue progressively?

Occasionally claims are made that states are constrained in their ability to raise revenue progressively because high-income households will simply move in response to higher taxes, or that cuts to corporate taxes will pay off so handsomely in terms of faster economic growth that spending should be slashed to accommodate these cuts. These claims are utterly without foundation.

In regard to flight of high-income households, most migration decisions seem to be made for reasons other than taxation (housing prices are a large factor), and while some small increase in out-migration following tax increases is possible, the evidence is clear that states get to keep the vast majority of all extra tax revenue that accrues to them following a hike in tax rates. Tannenwald, Shure, and Johnson (2011) provide a comprehensive review of the evidence on the effect of tax changes on migration and conclude that “recent research shows income tax increases cause little or no interstate migration.”

A more recent study, published in the American Sociological Review (ASR) by Young et al. (2016), uses state-of-the-art empirical techniques to precisely estimate the causal effect of tax hikes on high-income household migration. Its findings strongly support the Tannenwald, Shure and Johnson (2011) findings. Young et al. (2016) look at state-to-state migration of millionaires over a long period of time (1999 to 2011) and also look at a sharply-focused discontinuity analysis of millionaire populations along state borders that have seen one of the border states significantly raise top tax rates. Neither analysis shows a substantively significant effect on migration of tax rate changes. When Florida is excluded from the analyses, Young et al. find no statistically measurable effect of tax changes on migration at all.

An obvious plausible reason why state tax increases would be only weakly associated with out-migration is that taxes finance quality-of-life improvements that residents value. A state that continually cuts taxes in an effort to attract residents would find its amenities and services declining rapidly, and this would be a countervailing influence to the attraction of lower tax rates for potential migrants.

While there appear to be few economic constraints against raising revenue from progressive changes in personal income tax rates, academic studies also find very small to negative payoffs to cutting state corporate tax rates. The corporate income tax is a notably progressive tax. Recent years have seen growing calls to cut corporate income tax rates in the name of boosting business investment.

However, in a recent study, Ljungqvist and Smolyansky (2015) conclude: “We find little evidence that corporate tax cuts boost economic activity….”5 Indeed, the pressure to cut corporate tax rates seems disproportionate to any economic payoff estimated in the economics literature; a paper by Chirinko and Wilson (2010) identifies a key reason why: state-level business tax rates are extraordinarily sensitive to campaign contributions made by corporations.

Importantly, many states provide significant credits against businesses’ tax liabilities, driving a large wedge between the headline statutory business tax rate and the effective rate actually paid. Many of these credits are on fiscal “autopilot”—they are available each year with any review or needed legislation, unlike much discretionary spending. Much research shows that the alleged purpose of many of these business tax credits (spurring economic growth) could be more efficiently met with some other policy tool, as we highlight in the next section. Reducing inefficient business tax credits allows more revenue to be raised from the business sector without raising rates by simply broadening the business tax base.

Should state fiscal policymakers prioritize low taxes or high investments?

Thompson (2010) directly compares tax-cutting versus investments as state-level economic development tools. He finds:

The available evidence suggests that the most effective options for creating jobs, in the short- and long-term, are investing in infrastructure and building the skills of the current and future workforce. Tax cuts and business subsidies on the other hand, do little to create jobs in the short-run, and are not the most effective approaches to generating growth over the long-term.

Bartik (2006) examines state-level spending on education and its long-run economic payoff. He finds that the benefits of a coordinated across-state strategy of investing in early childhood education are at least 10 times larger than benefits from states cutting taxes to incentivize businesses.

A look at key indicators from Connecticut

Summary: The lessons from national data apply firmly to Connecticut as well, and Connecticut has ample room to raise revenue to support an investment agenda.

The national evidence is clear: raising taxes is a better strategy for closing state budget shortfalls than cutting spending. Of course, in theory there could be some states that have already maximized their options for raising taxes. An example would be any state that would need to raise its taxes so high to close budget shortfalls that the state would become an outlier in its tax burden and previous research could no longer be applied to its experience.

Connecticut is emphatically not one of those states. For example, in the year 2000, Connecticut state and local government spending as a share of gross state product (GSP) was 7.8 percent, versus an 8.9 percent average across states nationally. By 2015 this share was 8.3 percent in Connecticut versus 9.0 percent nationally. In short, it seems hard to argue that state and local government spending in Connecticut is so lavish that it is danger of pushing the needed state tax rates to levels outside the bounds of taxes in normal American states.6 Further, as Figure F highlights, the ratio of tax revenues to state personal income rebounded far more slowly in Connecticut in the aftermath of the Great Recession than it had from recessions in the early 1980s and 1990s.

Figure F

The Connecticut business sector is lightly taxed compared with other states’ business sectors

An annual ranking of state and local business taxes by Ernst and Young (2016) finds that Connecticut has one of the lightest business tax regimes in the country. As a share of gross state product (GSP), Connecticut is tied for the lowest business tax burden in the nation. As a share of total state and local taxes collected from businesses, Connecticut also ranks last. From 2014 to 2015, Connecticut business taxes remained largely unchanged, putting Connecticut in the bottom eight states with the smallest increases in business taxes in that year. In short, relative to other states, Connecticut has an extraordinary amount of room to ask more from businesses to help ease budget pressures.

Before the Great Recession, several New England states increased “tax expenditures” (government spending on tax credits, exemptions, deductions, etc.), usually justified as attempts to incentivize businesses to move to their states. Such measures substantially reduced state revenues before the Great Recession hit, leaving these states with smaller budget reserve funds and less flexibility to respond to the fiscal consequences of the downturn.7

Connecticut continues to rely on these type of incentives to encourage businesses to locate, hire, expand, and invest within its borders. In Connecticut, credits against businesses’ tax liabilities have grown from roughly $5 million in the early 1990s to over $160 million today. Yet the state itself found that several tax credit, abatement, and exemption programs have had negative or very limited positive impacts, while other programs have had little or no participation from businesses. Some of these programs have been recommended for elimination.

Ongoing assessment of the payoff and future policy for these tax credits is warranted. Research by Bartik (2006), for example, shows that for Connecticut, state payoffs from increased educational spending exceed payoffs from providing business tax incentives, by an order of 15 to 1. The Pew Center for the States (2012) considered the scope of each state’s tax incentive evaluations from 2007 to 2011, assessing whether states evaluated all major tax incentives and sought to ensure that policymaking was informed by the results. Connecticut scored well on its assessment of its tax incentive programs, but scored relatively poorly on testing whether those investments actually work.

Connecticut does not currently ensure that this information is considered when lawmakers decide whether to use tax incentives, how much to spend, and who should get them. The states of Washington and Oregon could serve as models of how to effectively use internal state data to inform policymaking in this area.8

When considering cutting corporate tax rates and looking to other states as models, it is also instructive to look at what happened in Kansas: In 2012, Governor Brownback led a successful campaign to cut corporate taxes, citing a growth payoff that would make this a sound economic strategy. These tax cuts, and the spending cuts used to finance them, proved harmful to Kansas’ budget and resulted in slower economic growth than that of neighboring states. As a result, the Kansas state legislature just passed a measure to reverse course and rescind most of the 2012 tax cuts.9 Like households, businesses care about taxes, but they also care about the quality and reliability of public goods and services that are essential for adequate and appropriate labor supply and access to markets.

Individual tax rates for top earners are lower than those of neighboring states

Moving from business taxes to individual taxes, Connecticut has lower top marginal income tax rates than two of its most important neighbors (New Jersey and New York). As Connecticut Voices for Children (CTVC 2017) has noted, even a half a percentage point increase in the top marginal income tax rate in Connecticut would boost state revenues by more than $200 million annually. Such an increase would still leave Connecticut’s top rates lower than those in New Jersey or New York.

Another measure that could potentially raise revenue in the near term and stabilize revenues over the business cycle over the long term is broadening the base for the state sales tax, including doing a better job collecting sales taxes on Internet purchases. CTVC (2017) have estimated that such sales tax base-broadening could raise revenue by over $1 billion.

Finally, by far the most effective method for stabilizing state spending over the business cycle in future years is simply being scrupulous in not squandering rainy day funds during relatively good economic times by indulging in tax-cutting. CTCV (2017) have identified a number of reforms meant to allow the state’s budget reserve fund to be protected from opportunistic tax-cutting during prosperous times.

Connecticut has failed to pursue an investment agenda

These measures—increasing tax revenues to boost and stabilize resources available to sustain state investments—are sorely needed. While spending data for Connecticut is slightly more encouraging than national averages on some measures, it remains too low overall. Figure G shows the share of GSP spent on state government public investment and K–12 education in 2000, 2007, and 2014 (comparing the latest year available with previous business cycle peaks). The latest years have seen declines in each measure. Some of this decline is driven by rising prices of both public investment goods (particularly the cost of construction materials) and education, but the upshot remains the same: the state’s public investment effort—including its K–12 spending—has fallen behind what is needed to ensure that the inflation-adjusted resources of the state flow to these vital goods.

Figure G

In 2014, the last year for which state data is available, the ratio of capital outlays (or public investment) by state and local governments to state-level GSP in Connecticut was 1.4 percent (see Figure H), placing it in the lowest fifth of states. In short, while Connecticut has ample room to raise revenue, it also has ample room to boost its public investments. All in all, Connecticut could benefit substantially from moving to a state budget strategy that emphasizes progressive revenue increases and ramped-up public investments.

Figure H

The Connecticut record in providing state support for higher education is even worse. Trostel and Ronca (2009) have constructed a comprehensive measure of state support for higher education that accounts for both state ability-to-pay as well as need. Trostel and Ronca define need as the total number of high school graduates in the previous four years and assume that all high school graduates—within classes, among states, and over time—are equal in needing higher education. They then measure state support as total state funding for higher education (all state and local government appropriations) divided by both a state’s average per-resident income and the total number of high school graduates over the previous four years. Using this metric, Connecticut ranks 45th among states.

This failure to undertake an investment agenda for higher education is short-sighted. Public investment in higher education translates into higher productivity growth and higher wages for typical workers (Fisher and Berger 2013). This investment is also fiscally positive in the long-run, resulting in higher tax collections and lower public-safety and income-support spending, which fully offset the cost of providing the education. While most of the fiscal benefits of higher education investments accrue to the federal government, it is still fiscally positive in the long run even from the narrower state perspective (Trostel 2015).

What is a better spending path for Connecticut to follow?

One benchmark for Connecticut public investment would be meeting the “Children’s Budget” target suggested by Thomas (2017) of Connecticut Voices for Children. This target calls for having 40 percent of the statewide budget devoted to resources that directly benefit children. Thomas notes that recent budgets have seen this “children’s share” drop to under 30 percent. Restoring a 40 percent target would require an annual increase of over $2 billion.

If Connecticut policymakers raised revenue from progressive sources by $2 billion annually in coming years and used this to boost public investments, this would result in state economic output that is roughly $2.2 billion larger and would support or create roughly 150,000 full-time equivalent (FTE) jobs over this timespan. The evidence for this is simply that the economic output multipliers for spending increases (see Table 1) average roughly 1.5 while multipliers for the economic drag of tax increases average roughly 0.4. This means that the net multiplier for a spending increase financed with progressive revenue increases is 1.1. This means that the $2 billion in spending (financed with progressive revenue sources) would yield an output of $2.2 billion.

Combining this output gain with data indicating that each full-time equivalent job in the national economy is associated with $145,000 in output yields the result that jobs would rise by roughly 150,000 due to this increase in investment effort.

Conclusion

State and local austerity have contributed enormously to the agonizingly slow recovery from the Great Recession. The spending cutbacks that have driven this austerity will also have adverse consequences for long-run productivity growth. While states do have to balance their budgets, there is clear economic evidence that this budget-balancing should lean more on progressive revenue increases and less on spending cuts. A high-investment state economic development agenda will provide payoffs in both near-term job creation as well as in long-run productivity growth and even in long-run benefits to the state fiscal situation. These conclusions apply generally across states, and they apply firmly to the situation in Connecticut as well.

About the author

Josh Bivens joined the Economic Policy Institute in 2002 and is currently the director of research. His primary areas of research include macroeconomics, social insurance, and globalization. He has authored or co-authored three books (including The State of Working America, 12th Edition) while working at EPI, edited another, and has written numerous research papers, including for academic journals. He often appears in media outlets to offer economic commentary and has testified several times before the U.S. Congress. He earned his Ph.D. from The New School for Social Research.

Endnotes

1. Recent reports that revenues have come in below expectations may well put further downward pressure on spending in subsequent budget proposals.

2. See Bivens (2015) for the definition of a healthy nominal wage target.

3. See Bivens (2016) for trends in government spending in the current recovery relative to earlier ones.

4. Government transfers include Social Security, Medicare, Medicaid, unemployment insurance, food purchasing assistance through the Supplemental Nutrition Assistance Program (SNAP), and subsidies from the Affordable Care Act (ACA), among others. Government consumption and investment includes work done by government employees directly (teachers, police, safety inspectors), as well as work financed by the government for which they receive a good or service (e.g., hiring a private construction firm to build or repair roads and bridges).

5. The full Ljungqvist and Smolyansky (2015) quote is: “We find little evidence that corporate tax cuts boost economic activity, unless implemented during recessions when they lead to significant increases in employment and income.” Importantly, this last caveat about corporate tax cuts boosting employment and income during recessions does not claim that corporate tax cuts should be a preferred fiscal tool for boosting near-term growth during or after recessions. Ljungqvist and Smolyansky do not compare the recession-fighting stimulus of corporate tax cuts with better-targeted fiscal measures, like public investments or progressively targeted transfers. As noted before, while corporate tax cuts do provide some positive fiscal stimulus when the economy suffers from slack demand, this is dwarfed by the boost given by better-targeted fiscal measures.

6. Author’s analysis of data from the Bureau of Economic Analysis (BEA) state and local gross domestic product (GDP) accounts.

7. See Thompson (2010) for this analysis of tax expenditures.

8. A recent vote by the Connecticut General Assembly’s Finance, Revenue and Bonding Committee has approved a measure that would move the state toward using this information better in future decisions. See the press release from the State of Connecticut Comptroller’s Office.

9. See Mazerov (2016) for this analysis of Kansas.

References

Bartik, Timothy J. 2006. The Economic Development Benefits of Universal Preschool Education Compared to Traditional Economic Development Programs. The Upjohn Institute for Employment Research. Report prepared for the Committee for Economic Development.

Bivens, Josh. 2011. Method Memo on Estimating the Jobs Impact of Various Policy Changes. Economic Policy Institute.

Bivens, Josh. 2012. Public Investment: The Next “New Thing” for Powering Economic Growth. Economic Policy Institute Briefing Paper no. 338.

Bivens, Josh. 2015. “A Vital Dashboard Indicator for Monetary Policy: Nominal Wage Targets.” Center for Budget and Policy Priorities Policy Futures Project.

Bivens, Josh. 2016. “Why Is Recovery Taking So Long—and Who’s to Blame?” Economic Policy Institute.

Bureau of Economic Analysis (BEA). Various years. National Income and Product Accounts. “1.1.4. Price Indexes for Gross Domestic Product,” “3.3. State and Local Government Current Receipts and Expenditures,” “3.9.4. Price Indexes for Government Consumption Expenditures and Gross Investment,” “3.16.6 Government Current Expenditures by Function,” and Regional Data tables [data tables].

Bureau of Labor Statistics (BLS). 2016. “Labor Force Statistics from the Current Population Survey.” [Excel file accessed February 23, 2017].

Bureau of Labor Statistics (BLS). Various years. Current Population Survey public data series. Aggregate data from basic monthly CPS microdata are available from the Bureau of Labor Statistics through three primary channels: as Historical ‘A’ Tables released with the BLS Employment Situation Summary, through the Labor Force Statistics database, and through series reports.

Cellini, Stephanie, Fernando V. Ferreira, and Jesse Rothstein. 2010. “The Value of School Facility Investments: Evidence from a Dynamic Regression Discontinuity Design.” Quarterly Journal of Economics vol. 125, no. 1, 215–261.

Chirinko and Wilson. 2010. “Can Lower Taxes Be Bought? The Role of Business Rent-Seeking in Tax Competition Among U.S. States.” National Tax Journal vol. 63, no. 4.

Chodorow-Reich, Gabriel. 2012. “Does State Fiscal Relief During Recessions Increase Employment? Evidence from the American Recovery and Reinvestment Act.” American Economic Journal vol. 4, no. 3, 118–145.

Connecticut Voices for Children (CTVC). 2017. “Revenue Options are Key to Addressing Budget Shortfalls and Supporting Thriving Communities.”

Ernst and Young. 2016. Total State and Local Business Taxes: State-by-State Estimates for Fiscal Year 2015. Prepared in conjunction with the Council on State Taxation (COST) and the State Tax Research Institute.

Fisher, Peter, and Noah Berger. 2013. A Well-Educated Workforce Is Key to State Prosperity. Economic Policy Institute.

Ljungqvist, Alexander, and Michael Smolyansky. 2015. “To Cut or Not to Cut? On the Impact of Corporate Taxes on Employment and Income.” Board of Governors of the Federal Reserve System Finance and Economics Discussion Series 2016-006.

Mazerov, Michael. 2016. “Kansas’ Tax Cut Experience Refutes Growth Predictions of Trump Tax Advisors.” Center for Budget and Policy Priorities.

Orszag, Peter, and Joseph Stiglitz. 2001. “Budget Cuts vs. Tax Increases at the State Level: Is One More Counter-Productive Than the Other During a Recession?” Center for Budget and Policy Priorities.

Pew Center on the States. 2012. “Evidence Counts: Evaluating State Tax Incentives for Jobs and Growth.”

Shoag, Daniel. 2013. “Using State Pension Shocks to Estimate Fiscal Multipliers since the Great Recession.” American Economic Review vol. 103, no. 3, 121–24.

Tannenwald, Robert, Jon Shure, and Nicolas Johnson. 2011. Tax Flight Is a Myth: Higher State Taxes Bring More Revenue, Not More Migration. Center on Budget and Policy Priorities.

Thomas, Derek. 2017. “Connecticut’s Declining Children’s Budget: Total Spending Devoted to Children Lowest on Record.” Connecticut Voices for Children.

Thompson, Jeffrey. 2010. Prioritizing Approaches to Economic Development in New England: Skills, Infrastructure, and Tax Incentives. Political Economy Research Institute.

Trostel, Philip. 2015. It’s Not Just The Money: The Benefits of College Education to Individuals and to Society. Lumina Foundation.

Trostel, Phillip, and Justin M. Ronca. 2009. “A Simple Unifying Measure of State Support for Higher Education.” Research in Higher Education vol. 50, no. 3, 215–247.

U.S. Census Bureau. Various years. Current Population Survey Data on School Enrollment, Historical Tables. Accessed February 23, 2017.

U.S. Census Bureau. Various years. State and Local Government Finance data. Accessed February 23, 2017.

Wilson, Daniel J. 2014. “Fiscal Spending Jobs Multipliers: Evidence from the 2009 American Recovery and Reinvestment Act.” American Economic Journal vol. 4, no. 3, 251–82.

Young, Cristobal, Charles Verner, Ithai Z. Lurie, and Richard Prisinzano. 2016. “Millionaire Migration and Taxation of the Elite: Evidence from Administrative Data.” American Sociological Review vol. 81, no. 3, 421–446.

Zandi, Mark. 2010. The Economic Impact of Tax Cut Proposals: A Prudent Middle Course. Moody’s Analytics.

• Stand firm against any plan that includes net tax cuts for high-income households and corporations.

This means rejecting plans that include net tax cuts for high-income households and corporations but also offer crumbs to progressives, either in the form of “middle-class tax cuts” or infrastructure spending.

• Resist the urge to base opposition to tax cuts for high-income households on concerns about increasing the federal budget deficit.

Stand firm against any plan that includes net tax cuts for high-income households and corporations

Since 1979, the share of total national income claimed by the richest 1 percent of households has increased substantially. Yet the effective tax rate (including the incidence of corporate income taxes) on this group was lower in 2013 (the latest year for which data are available) than in 1979. The U.S. economy has worked extraordinarily well for those in the top 1 percent of the income distribution in recent decades (see Figure A). Tax cuts that give these families a vastly disproportionate share of the benefits should not be a policy priority.

Figure A

In the longer run, with a different Congress, the progressive priority should be to increase effective tax rates on the top 1 percent. These top effective rates were boosted in the later years of the Obama administration, but they remain below their 1979 levels, even as incomes of top 1 percent households grew several times faster than incomes of middle-class households. While the long-run fiscal situation of the United States is fundamentally strong, we will need more revenue in the future to honor existing commitments to social insurance, income support, and public investment, let alone to expand these commitments. It just makes sense that this revenue should come from the group that has done extraordinarily well over recent decades.

Further, a growing research base indicates that the decline in top effective rates has contributed substantially to rising inequality in recent decades.1 Essentially, these rate cuts have powerfully boosted incentives for well-placed economic agents (think CEOs and finance sector professionals) to rig the rules of the economy to direct a disproportionate share of the benefits of economic growth to themselves. In simple terms, they have more reason to use their political and economic power to steer the fruits of economic growth their way because lower taxes means they get to keep a greater share of what they claim. While progressives should aim to stop the rigging of these rules in each particular case (through financial regulation or improved corporate governance, for example), tax reform that raised the effective rate on top income households could significantly blunt the incentive for this rule-rigging across-the-board.2

In this hypothetical policymaking world—one with a more progressive and evidence-based Congress—one could also imagine corporate tax reform that lowers the statutory rate yet closes loopholes to keep net revenue collected from the corporate income tax unchanged (or even increase it). We could also imagine proposals that radically scale back the corporate income tax yet boost progressive taxes on the individual side (or through financial transactions taxes) to keep the overall system at least as progressive as it is today. These theoretical possibilities are why we formulate this principle as opposing “net tax cuts for high-income households and corporations.” In reality, though, in the current debate this will almost surely end up meaning that any cuts in either individual or corporate rates should be opposed, since today’s Republican majority is not interested in reform that does anything but increase the post-tax incomes of the richest households.

To be sure, today’s corporate income tax system is riddled with damaging loopholes that intelligent tax reform should close. The most important one to close is the ability of U.S. firms to defer taxation on profits earned abroad (or at least profits engineered to appear to have been earned abroad). Deferral is why it is rational for firms to shift their profits abroad, and it is why more than $2.5 trillion in profits are now sitting offshore untaxed.3 This overseas hoard of profits will put enormous pressure on policymakers to cut a deal to have this money brought back into the country at a very low tax rate. The economic case that repatriating this money at a preferential tax rate will yield large-enough benefits to justify the revenue loss is extraordinarily weak.4 Today’s U.S. economy remains glutted with savings, as demonstrated by interest rates that remain historically low and corporate balance sheets that are so awash in cash that they could essentially finance planned capital investment with internal funds.5 There is no benefit to either near-term or long-term U.S. growth from giving a select group of some of the world’s richest corporations an enormous tax break in exchange for their repatriation of overseas profits, a repatriation that will only increase the savings glut without boosting job growth. But there is a benefit from preserving the corporate income tax, as it is among the most progressive parts of the U.S. tax system; mainly it falls heaviest on capital-based income, which is concentrated at the top of the income distribution (Figure B).

Figure B

Reject plans that offer crumbs to progressives, either in the form of “middle-class tax cuts” or infrastructure spending

Some Democrats in Congress might seek to avoid being labeled the “party of no” by trying to strike a deal on taxes. It is almost inconceivable that any deal driven by the Republican majority will not include large tax cuts for the richest households and/or corporations. Given this, hopes for an acceptable deal should be very low. Crucially, appending some small-scale progressive priorities to a tax bill that provides huge benefits to the richest households should be unacceptable.

One common locus of potential dealmaking concerns “middle-class tax cuts.” Progressives should be clear about something: the federal income tax rates faced by middle-class Americans have nothing to do with their struggles to maintain economic security amid stagnating living standards in recent decades. In fact, the effective federal income tax rate faced by the bottom 80 percent of American households has fallen enormously between 1979 and 2013 (see Figure C below). And yet pretax income of this group has fallen ever-further far behind economy-wide averages, held down by rising inequality (see the red line in Figure C). At some point, policymakers genuinely concerned about boosting incomes for middle-class families will have to realize that middle-class tax rates are a pathetically weak lever to pull, and they should move on to other policies that will actually help these families.6

Figure C

Demands that progressives present “their plan” for boosting middle-class incomes should be easy to answer. First, we want to raise more revenue from the top, both to honor—and even expand—current commitments to social insurance and income support and to fund public investments in the future. Second, we want to use every lever in the policy toolkit—not just tax policy—to shift economic leverage and bargaining power toward low- and moderate-wage households.7 What we refuse to do is engage in voodoo economics by claiming that cutting effective middle-class income tax rates from 4 percent to 3 percent will somehow be game changing for the middle class.

Besides calls for “middle-class tax cuts,” the other siren song for Democrats who want to make deals during the upcoming tax debate will be promises to bundle infrastructure investments in a package of tax cuts. Expanded public investment of all types—including infrastructure—have been a progressive priority for years.8 And yet it is enormously unlikely that any forthcoming tax deal will include an attractive-enough infrastructure plan to be worth swallowing enormous, regressive tax cuts.

For one, any policy package that includes both large tax cuts and increased infrastructure spending will almost by definition need to come with steep cuts in other parts of the federal budget. We know such cuts are a Republican priority, as exemplified both by the Better Way plans forwarded by Speaker Ryan as well as by President Trump’s recent “skinny budget.” Any such federal budget cuts would completely neutralize any near-term job-creation benefit from infrastructure spending, eliminating much of the rationale for infrastructure investment.9

Further, the infrastructure proposals that have been issued by Republicans in recent years have been exercises in marketing rather than serious economic proposals. Their common theme is putting minimal amounts of federal spending into these plans and then making large, unfounded claims that this small amount of federal spending will “leverage” massive amounts of private capital to invest in infrastructure.10 The plan issued in 2016 by Peter Navarro and Wilbur Ross for the Trump campaign is essentially a recipe for giving tax breaks to firms that were going to be involved in infrastructure projects anyhow, without inducing any additional investment; roughly $400 billion in infrastructure investment happens each year even without any particular policy intervention to increase it.11

Resist the urge to base opposition to tax cuts for high-income households on concerns about increasing the federal budget deficit

Arguing against regressive tax cuts by amplifying fears about too-large federal budget deficits is bad economics and bad political strategy. It is bad economics because the U.S. economy’s fiscal position is fundamentally solid.12 There is no evidence that fiscal profligacy is either harming us now or is poised to harm us anytime soon. Long-term interest rates and inflation remain low. The single largest driver of long-run spending trends is the growth in per capita health care costs, and these costs have slowed significantly over the past decade. The estimated 30-year fiscal gap—how much (starting today) taxes would need to be raised or spending would need to be cut to hold the debt-to-GDP ratio constant—has also narrowed. In its 2016 Long-Term Budget Outlook, the Congressional Budget Office (CBO) has the 30-year fiscal gap at under 2 percent, down significantly from estimates made a decade ago.

Further, the economy remains damaged by the Great Recession, with several indicators demonstrating a remaining gap between aggregate demand and potential supply (see Figure D). For example, the share of 25- to 54-year-olds with a job is still too low: the prime-age employment-to-population ratio (EPOP) remains substantially below its 2007 peak, and far below the peak it reached in 2000. Because this is a fixed-age group, this is not a story of rising college enrollments or retirements caused by demographic change. Key evidence that this historically depressed prime-age EPOP is due to the slack in demand comes from the still-sluggish growth in nominal wages, which have yet to break 3 percent annualized growth over the entire course of the recovery from the Great Recession. This growth rate is far below the level—3.5 percent and above—needed to restore the economy’s overall price growth and labor share of income to historically normal levels.13 Finally, core prices remain below the Fed’s target for a healthy economy, and have been below this target for years now.

Figure D

The relevance of this demand-slack for fiscal debates is that anything that convinces policymakers to prioritize rapid reductions in the federal budget deficit will drag on growth and prolong the years-long failure to engineer a full recovery. This is not an academic concern. The enormously premature “pivot to austerity” that characterized fiscal policy in 2011 became by far the single biggest reason why the recovery from the Great Recession has been the slowest on record.14 If concerns about budget deficits somehow convince Congress to pair regressive tax cuts with spending cuts, this would be a near-term macroeconomic disaster, as the fiscal drag from spending cuts would easily swamp any stimulus from high-income tax cuts.

Crucially, fomenting the misperception that the federal budget deficit is always too large and growing is pure poison for long-run progressive goals. As public opinion expert Ruy Teixeira has put it, “Arguably, there is no greater obstacle to progressive change than the idea of austerity.”15 Pollster Celinda Lake has also noted evidence that stirring up deficit concerns in the short run to fight destructive tax cuts boomerangs, harming progressive efforts to boost social insurance, safety net, and public investment spending.16 The broader public often quickly translates concerns over budget deficits into concerns over spending, and convincing the broader public that any growth in spending programs is doing damage to the U.S. economy is the linchpin of conservative efforts to pare back the already pretty threadbare American system of social insurance, income support, and public investment.

While invoking deficit fears is bad economics and bad strategy, noting implicit trade-offs can be illuminating. That is, regardless of the pluses or minuses of what regressive tax cuts do to budget deficits, they unambiguously represent resources that the federal government will no longer have. It seems perfectly reasonable to ask why, for example, Speaker Ryan believes that the federal government has $3 trillion in revenue to give away to the top 1 percent (literally 99.6 percent of his plan’s benefits accrue to the top 1 percent by 2025), but not $3 trillion to boost health coverage, or fix the nation’s eroded unemployment insurance system, or expand Social Security, or undertake substantial public investments.17 But it is not economically rational or politically astute to claim that tax cuts should be dedicated to “paying down debt,” or that today’s fiscal situation is already dire and hence tax cuts just make it worse. Today’s fiscal situation is not dire; the only thing standing between the United States and the ability to not just honor, but expand, the federal programs that provide crucial help to low- and moderate-income households is the tax-cuts-over-everything-else ideology of the Republican Party.

About the author

Josh Bivens joined the Economic Policy Institute in 2002 and is currently the director of research. His primary areas of research include macroeconomics, social insurance, and globalization. He has authored or co-authored three books (including The State of Working America, 12th Edition) while working at EPI, edited another, and has written numerous research papers, including for academic journals. He often appears in media outlets to offer economic commentary and has testified several times before the U.S. Congress. He earned his Ph.D. from The New School for Social Research.

Endnotes

1. The overview and empirical evidence linking falling top tax rates and rising inequality can be found in Thomas Piketty, Emmanuel Saez, and Stefanie Stantcheva, “Optimal Taxation of Top Labor Incomes: A Tale of Three Elasticities,” American Economic Journal: Economic Policy, vol. 6, no. 1, February 2014.

2. For more on this argument see Josh Bivens and Lawrence Mishel, “The Pay of Corporate Executives and Financial Professionals as Evidence of Rents in Top 1 Percent Incomes,” Journal of Economic Perspectives, vol. 27, no. 3, summer 2013.

3. For estimates of the scale of corporate profits parked offshore deferring taxation see Richard Phillips et al., Offshore Shell Games 2016: The Use of Offshore Tax Havens by Fortune 500 Companies, U.S. PIRG, Citizens for Tax Justice, Institute of Taxation and Economic Policy, October.

4. The benefits of the last repatriation holidays in 2014 are surveyed in Chuck Marr and Chye-Ching Huang, Repatriation Tax Holiday Would Lose Revenue and Is a Proven Policy Failure, Center on Budget and Policy Priorities, 2014.

5. See a forthcoming EPI report by Josh Bivens and Hunter Blair for evidence that corporate internal funds can finance planned investment to a historically large degree (working title: “Competitive” Gibberish: The Flawed Evidence and Logic behind Claims that Corporate Tax Rates Are Too High, Economic Policy institute, 2017).

6. For more on why middle-class income tax cuts are such a limited strategy, and a review of policies that would actually help middle-class families, see Lawrence Mishel, “Even Better than a Tax Cut,” The New York Times [op-ed], February 23, 2015.

7. EPI’s “Agenda to Raise America’s Pay” presents a comprehensive set of policies for boosting American workers’ pay.

8. EPI, for example, was recommending a substantial increase in infrastructure spending as an alternative to the Economic Stimulus Act of 2008—fully a year before the American Recovery and Reinvestment Act (ARRA). See John Irons, Lawrence Mishel, and Ross Eisenbrey, Strategy for Economic Rebound: Smart Stimulus to Counteract the Economic Slowdown, Economic Policy Institute, January 11, 2008.

9. For the finding that cuts to federal spending (particularly transfers) will near-totally neutralize the short-term job-creation benefits of infrastructure spending, see Josh Bivens, The Short- and Long-Term Impacts of Infrastructure Investments on U.S. Employment and Economic Activity, Economic Policy Institute, 2014.

10. For a review of common weaknesses regarding claims of the benefits of “engaging the private sector,” see Hunter Blair, No Free Bridge: Why Public–Private Partnerships or Other ‘Innovative’ Financing of Infrastructure Will Not Save Taxpayers Money, Economic Policy Institute, 2017.

11. For an analysis of how to evaluate public investment plans see Josh Bivens and Hunter Blair, A Public Investment Agenda that Delivers the Goods for American Workers Needs to be Long-lived, Broad, and Subject to Democratic Oversight, Economic Policy Institute, 2016.

12. See Harry Stein, “America Can Still Do Big Things: Dispelling the Fiscal Hysteria that Thwarts
Good Public Policy,” Harvard Law & Policy Review, vol. 11, 2017, for an excellent overview of the fundamentally sound fiscal position of the United States.

14. See Josh Bivens, Why Is Recovery Taking so Long—and Who’s to Blame?, Economic Policy Institute, 2016, on the role played by austerity in leading to slow growth following the Great Recession.

15. See Ruy Teixeira, “Austerity: The Biggest Roadblock To Progressive Change,” ThinkProgress (Center for American Progress blog), April 26, 2013.

16. Pollster Celinda Lake made this point in a talk during remarks delivered at The New Populism Conference in Washington, D.C., May 22, 2014.

17. See James R. Nunns et al., An Analysis of the House GOP Tax Plan, Tax Policy Center, 2016, for an analysis of the House Republican tax plan from last year.

Background

The Fair Labor Standards Act (FLSA) requires employers to pay certain employees time-and-a-half (or 1.5 times) their regular pay rate for each hour of work per week beyond 40 hours. For nearly 80 years, this system has struck a successful balance by giving employers a way to get work done at a fair price while protecting employees’ time with their families. Most hourly workers are guaranteed the right to overtime pay, while salaried workers’ eligibility is based on their pay and the nature of their duties. Most salaried workers who earn less than $455 per week ($23,660 annually) are automatically eligible for overtime pay, regardless of their job duties. Salaried workers who earn $455 per week or more may be exempt from guaranteed overtime if their job duties fall into one of three categories: professional, administrative, or executive. The duties associated with these categories involve supervisory responsibilities or a high degree of control over their time and tasks because these exemptions from guaranteed overtime were intended to apply to only a small segment of workers who perform relatively high-level work with a salary that reflects this.

However, the salary threshold has been updated only once since the 1970s—in 2004, when it was set too low. As a result, the share of the salaried workforce that earns less than the threshold has shrunk significantly. Consider that in 1979 nearly 12 million salaried workers had overtime protections. But today, with a 50 percent larger workforce, only 3.5 million salaried workers are automatically protected.2 Workers who have lost overtime protection based on an outdated salary threshold have lost not only the right to be paid time-and-a-half for their overtime—they have lost the right to be paid for it at all. And now that overtime hours do not cost employers extra money, they are more likely to require workers to work longer hours. No wonder so many workers feel that they need “flexibility” to balance family responsibilities. Employers have no incentive not to require those workers to work extra hours.

Obama-era rule

The deterioration of overtime protections led to the promulgation of a Department of Labor rule to restore the salary threshold to a meaningful level. The rule—scheduled to take effect on December 1, 2016, but blocked by an injunction that is on appeal in the U.S. Court of Appeals for the Fifth Circuit—raised the threshold from $455 to $913 per week (or from $23,660 to $47,476 for a year-round worker). The rule would directly benefit a wide range of workers including 6.4 million women and 4.2 million parents.3

Working Families Flexibility Act

The Working Families Flexibility Act would amend the FLSA to allow private-sector employers to “compensate” hourly workers with compensatory time off in lieu of overtime pay. Contrary to proponents’ claims, the bill does not create employee rights, it takes them away. It does create a new employer right—the right to delay paying any wages for overtime work for as long as 13 months. The legislation forces workers to compromise their paychecks for the possibility—but not the guarantee—that they will get time off from work when they need it.

Congressional Republicans have introduced versions of this legislation for the past 20 years:

• H.R. 1, the Working Families Flexibility Act of 1997, which sought to amend the FLSA to extend comp time to the private sector.
• H.R. 1119, the Family Time Flexibility Act, which proposed extending comp time to the private sector in 2003.
• H.R. 6025, the Family Friendly Workplace Act, a nearly identical comp-time bill introduced in 2008.
• H.R. 933, a reintroduction of the Family Friendly Workplace Act in 2009.

Despite the marketing, none of these bills would have resulted in greater flexibility for workers. Instead, they would have simply allowed employers to avoid paying overtime. Workers depend on the wage and overtime protections in the FLSA. They should not have to sacrifice earned wages to have flexibility.

FLSA already provides flexibility

The FLSA is the original family-friendly law. It permits a wide range of flexible work schedules. For example, under current law, public and private employers may choose to allow their workers to vary the start or end of their workday, including on an ad-hoc basis. Employers may also choose to permit employees to schedule four 10-hour days with one workday off, or arrange nine-hour workdays with a day off every other week. All of these arrangements are permissible under the FLSA. Employers can and should take advantage of the flexibility the current law already provides.

Perhaps most revealing, under the FLSA, an employer may pay an employee for overtime worked in a given week and then, to reward the employee for putting in extra time, may schedule future unpaid time off. The result would be that the total annual hours worked and income received would be the same as under Rep. Roby’s comp time in lieu of overtime proposal, but workers would not have to wait for up to 13 months to be paid for the overtime hours. In other words, everything the comp time bill purports to provide for workers is actually available under the FLSA.

The bill will reduce worker income

The Working Families Flexibility Act would result in less money in employees’ paychecks, even when they do work overtime. Many employees rely on overtime pay to earn enough money to make ends meet every month—but this bill would allow employers to avoid paying overtime premiums when employees work extra hours, by giving them “comp time” to bank for future use instead. This means employees will still be working longer hours, but they will be receiving less in their paychecks at the time they work the longer hours. They will essentially be loaning their employer their overtime pay (at no interest) for as long as 13 months.

Under the legislation, an employee may decline to accept comp time in lieu of overtime. It follows that employers will assign overtime preferentially to those who accept comp time, thereby depriving the workers who need the extra cash of opportunities for overtime work. So, not only will the employees who receive comp time instead of overtime pay earn less, so will the employees who refuse comp time and insist on being paid overtime pay.

The bill would give employers—not employees—the right to control comp time

Nothing in the bill guarantees a worker that she will be able to use accrued comp time hours when she needs to access them. Under the legislation, an employer may deny a worker’s request for comp time if it “unduly disrupts the operations of the employer.” This broad standard for denying overtime provides employers with enormous control over employees’ access to comp time.

Furthermore, because the bill provides inadequate penalties, there is little incentive for unscrupulous employers to provide meaningful access to comp time. (An employer is liable for only the wages owed as well as liquidated damages reduced by each hour of comp time used by the employee.) Instead of providing meaningful access to comp time, employers could simply assert undue disruption to their operations in response to a request for a comp time hour and deny a worker the requested time off and continue to avoid paying overtime wages. The bill does not require employers to pay employees interest on their comp time pay, which employees would receive if they put their overtime pay in the bank, so the employer gets to keep any interest earned on the wages held as well.

The bill would lead to unpredictable schedules for workers

• The comp time bill undermines the fundamental goal of the FLSA’s overtime rules: to discourage employers from overworking employees by making it more expensive for them to do so.
• Allowing employers to give “comp time” cheapens the use of overtime since employers don’t have to pay out overtime premiums when the work is actually done.
   Because this bill makes overtime work cheaper for the employer, employers will be more likely to schedule mandatory overtime more often. 
• The employer, not the employee, has the final say over when comp time can be used. Employers can deny an employee’s request to use comp time hours if they feel it would “unduly disrupt” the employer’s business. And employees are required to make a request in advance without any leeway in emergency situations. Accordingly, many employees will work a lot of overtime and find their leave banks full at the end of the year. If workers don’t manage to use at least two-thirds of their banked comp time, they will actually have worked more hours during the year, not less.

Why comp time won’t work in the private sector

Proponents of comp time in lieu of overtime pay argue that public-sector employees receive this benefit and it should be extended to private-sector workers. However, there is little information available on the use of and experience with comp time in state and local governments, making it impossible to determine whether workers are able to meaningfully access comp time under the system. Furthermore, there are important differences between the public-sector workforce and the private-sector workforce that make comp time riskier for private-sector workers. Public-sector workers can’t be fired except for good cause, they have administrative appeal rights, and they have significantly higher rates of union representation. These considerations make them more likely to challenge an employer’s decision denying them the use of comp time and less likely to be coerced into agreeing to comp time in lieu of overtime pay. And, while nothing in this legislation provides any guarantee that a worker will ever be able to take the comp time that she accrues when she needs it, private-sector workers also face a real danger of losing comp time accrued in the event of a business failure. According to the Small Business Administration, in 2013, over 400,000 small businesses closed.4 Nothing in the legislation provides workers whose employer goes out of business with a guarantee to receive payment for accrued comp time. The employer is not required to put sufficient money in escrow or to buy a bond to guarantee payment in case of closure or bankruptcy.

Conclusion

At no risk to the employee, the FLSA already allows an employer to grant time off to employees who work overtime. H.R. 1180 adds nothing but delay and risk to the employees’ right to receive extra compensation when they work more than 40 hours in a week.

Endnotes

1. Ross Eisenbrey and Lawrence Mishel, The New Overtime Salary Threshold Would Directly Benefit 13.5 Million Workers, Economic Policy Institute report, August 2015.

2. Ross Eisenbrey, Testimony before the United States Senate Committee on Small Business and Entrepreneurship, May 11, 2016. Current statistics referred to are as of 2014.

3. Ross Eisenbrey and Will Kimball, The New Overtime Rule Will Directly Benefit 12.5 Million Working People, Economic Policy Institute report, May 2016.

4. U.S. Small Business Administration Office of Advocacy, “Frequently Asked Questions,” June 2016.