Cutting labor income taxes brings back jobs for those hit hard by Covid-19

Can a fiscal stimulus help bring back jobs for those struck by the Covid-19 recession? Research by Roland Winkler (University of Antwerp), Christian Bredemeier and Falko Juessen (University of Wuppertal) indicates that it depends on how the stimulus is designed. A cut in the tax rate on labor income performs best in stimulating job creation for those who have borne the brunt of job losses. 

Pink-collar recession

Job losses in the Covid-19 downturn are enormous and have been unfolding at unprecedented speed. The crisis also stands out because the mix of workers who have been struck is unusual. In a typical recession, blue-collar workers in construction and manufacturing suffer worst. This time, however, workers in sectors with a high worker-client interaction and occupations that are personal-service-oriented bear the brunt of the recession.

“In the U.S., where the labor market collapse is particularly strong, the crisis has destroyed 10 million jobs in ‘retail trade’ and ‘leisure and hospitality’ industries. One out of three workers in service occupations lost their job. This is why some call the Covid-19 recession a “pink-collar recession’’. However, blue-collar workers have been suffering from heavy job losses too.”

Economic recovery

During the initial phase of the pandemic, the essential role of governments was to fight infections and to avoid hardship and bankruptcies for households and firms. When infections are under control and restrictions are slowly relaxed, the government will give more focus to supporting demand and helping the economy recover faster.

In this phase, economic policy should not only concentrate on pushing up the total number of jobs but should also be concerned for whom jobs are created during the recovery. After all, an unemployed sales clerk will benefit little if fiscal policy stimulates firms to hire software engineers.

Stimulus programs

The economists from Antwerp and Wuppertal wanted to know how a stimulus package should be designed to promote job creation for those hit hardest by the Covid- 19 recession. To address this question, they used a macroeconomic model of the U.S. economy to simulate several potential stimulus programs, which, if implemented, would help the economy recover faster.  They then investigated how the different stimulus plans would affect employment by industry and occupation.

The model simulations show the following:

    1. A fiscal stimulus promotes job growth in pink-collar occupations as well as in sectors with a high intensity of worker-client interaction. In this sense, fiscal policy is successful in helping create jobs where they were lost during the Covid-19 crisis.
    2. Stimulating blue-collar job creation is more challenging. Only a cut in labor income taxes would quicken the recovery for blue-collar workers considerably. That’s why a reduction in taxes on labor income outperforms other stimulus programs in stimulating job creation for all those who lost their job in the Covid-19 downturn.

Occupational differences

The reason why fiscal stimulus measures affect employment by occupation differently is that there are differences in ‘capital-labor substitutability’. This term indicates how easy it is for firms to replace workers by machines.

“Replacing jobs that involve a substantial share of direct human interaction (most pink-collar occupations) is not easy. By contrast, machines can relatively easily replace many blue-collar jobs, which explains why blue-collar workers have suffered most from automation.”

If the government now supports aggregate demand to accelerate the recovery, firms will start using their machines more intensively again, which currently are lying idle. They can do so without calling back many blue-collar workers.

Reduced labor income tax

The authors show that this mechanism is essential: even if the government channeled a lot of additional spending into industries that employ many blue-collar workers, blue-collar employment would still benefit the least.

To stimulate job creation for this group of workers, the government needs to incentivize firms to enlarge their payroll by more than they raise their use of machines. This will happen if the government reduces the tax on labor income. With this stimulus, the government would not only boost the recovery, but it would also create jobs for those workers whom the Covid-19 crisis hurt the most.

Bringing back the jobs lost to Covid-19: The role of fiscal policy’, by Christian Bredemeier (University of Wuppertal), Falko Juessen (University of Wuppertal), and Roland Winkler (University of Antwerp).

The study has been published in Covid Economics, an online journal of the renowned Center for Economic Policy Research in London, that disseminates real-time research on the economics of the Covid-19 pandemic.

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