Who's In, Who's Out? Policy to Address Job Rationing During Recession

Abstract

In response to the Great Recession, the federal government spent hundreds of billions of dollars in tax and other interventions in the labor market as part of the stimulus and follow-up policies. Policymakers traditionally have based their policies on "Keynesian" theories that recessions are driven by inadequate demand, so that increasing government spending will increase demand for economic activity and workers. However, these theories guide how much to spend, not how to design the spending. As a result, despite this massive outlay of funds, the theory for the form that labor income taxes and related policies should change during recessions is surprisingly poorly developed. Instead of drawing on Keynesian macroeconomic theories, we draw on the microeconomics literature on how labor markets function during recessions-in particular, the literature on matching unemployed workers with firms. Insights from microeconomics help answer why there are "too few" jobs and which workers gain employment. The Article draws two counterintuitive conclusions for maximizing social welfare during slack labor markets during and after recessions. First, subsidize nonemployment. This draws marginal workers out of the labor force, creating space for those who really need jobs. Second, subsidize employers for hiring, not the employees themselves. The problem during recessions is having too few jobs. Econometric evidence shows that statutory incidence matters for economic incidence during recessions; subsidizing employers creates more jobs, while subsidizing employees confers benefits on those who already won the job lottery. Policy during and after the Great Recession often did not follow these recommendations.