Bloomberg View: Two Policies to Keep From the Fiscal Cliff

Illustration by Bloomberg View

Almost lost in the fiscal cliff debate is whether to extend two programs that have helped bolster the economy over the past four years by putting more money in consumers’ pockets. The payroll-tax holiday and extended federal unemployment benefits will end in January absent congressional action. Their expiration would save the U.S. about $145 billion next year—but shave about 1 percentage point off economic growth.

The U.S. economy is too fragile to withdraw support cold turkey. About 12 million people are unemployed, and 40 percent have been out of work six months or longer. The Federal Reserve expects the 7.7 percent unemployment rate to decline only slightly, if at all, in 2013.

A more prudent course would be to continue the programs for another year on a smaller scale. The payroll tax cut could be scaled back. The U.S. now deducts 4.2 percent from paychecks, down from the standard 6.2 percent. A 5.2 percent tax would halve the program’s estimated $114 billion annual cost while still letting workers take home more pay.

And if the payroll cut went away entirely? More than 122 million workers would see an immediate tax increase of $920 on average, according to the nonpartisan Tax Policy Center.

Ending extended unemployment benefits would be similarly misguided. States can bolster their roughly 26 weeks of jobless benefits with up to 47 additional weeks through two federal programs. The duration of benefits, which are pegged to a state’s jobless rate, has been declining as the employment situation improves. In 10 states, benefits have already gone from a maximum of 99 weeks to as few as 40.

The number of weeks will continue to fall in tandem with the jobless rate. The Congressional Budget Office estimates that extending federal insurance another year would cost the U.S. about $30 billion in 2013, down from $159 billion in 2010.

The biggest knock against extending unemployment coverage is that it provides an incentive to remain outside the workforce. One economist at the University of California at Berkeley found the jobless rate in December 2010 would have been about 0.2 percentage point lower, absent extended benefits. A paper by economists at the Federal Reserve Bank of San Francisco concluded that 99-week benefits pushed up the jobless rate even more—as much as 0.8 percentage point.

While extended benefits may dissuade some from taking jobs or engaging in more intensive searches, the primary cause of long-term unemployment is a slack labor market. And jobless benefits are a powerful form of stimulus: The money is likely to be spent on food, rent, gas, and other immediate needs. Cutting off the program would hurt demand and slow economic output in 2013 by about 0.35 percentage point, according to various estimates. It would be folly if lawmakers, in their zeal for immediate fiscal tightening, eliminated extensions to the payroll tax cut and unemployment insurance only to see the economy go wobbly again—and the deficit shoot back up.

Before it's here, it's on the Bloomberg Terminal.