Arnold Kling  

Reducing Real Compensation

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Alex Tabarrok highlights a post by David Beckworth on the sharp decline in nominal spending in 2008-2009. Alex writes,

We could use some inflation to get back on track. Nominal wages are simply not flexible enough to get the job done in short order

I would caution that lower real wages are only part of the solution to the Recalculation problem. The process also will involve transitions into and out of industries and occupations.

But it certainly would not hurt to reduce real compensation. Some ideas for doing this:

1. Cut the employer contribution to the payroll tax. Bryan first proposed this, and others, including Alex and myself, have pushed it since.

2. Reduce employer-provided health benefits, but not by taxing those benefits. Instead of expanding the government mandate for employer-provided health insurance, the government should mandate cuts in employer-provided health benefits. I am not saying that this is good health care policy (although I could make a case that it is), but it is certainly good recession-fighting policy.

3. Direct stimulus funds toward flexible-wage sectors of the economy. That is, not toward state and local governments. Or else tie state and local stimulus funds to provisions requiring salary freezes at recipient governments. Require state and local governments to use the lowest-cost contractors, rather than go with union contractors.

4. Reduce the leverage of labor unions generally.

Of course, a political party dedicated to increasing labor's share of income (at least for those fortunate enough to have jobs) is not going to enact any of these policies. The friend of labor is the enemy of full employment.

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COMMENTS (5 to date)
Doc Merlin writes:

I should point out that minimum wage was raised about 40% and that effect wont go away without some inflation. Also that private sector wages are less sticky than they were in the 70's and 80's due to less union involvement.

David Zetland writes:

I'd go further on the employer contribution to health care. If that contribution was converted into salary (for $0.90 on the $1 of premia), then employers would save money (still tax deductible) AND employees would take control over their health insurance. The combination of more competition, a desire to keep more of the premium AND the 10% cut they just took (whoops! sorry!) would put massive downward pressure on costs. More here.

Rich writes:

What exactly is the "payroll tax"? Is it Social Security? Medicare? FUTA? State UI? All four?

Perhaps I'm wrong but I was under the impression that there is no "payroll tax" in the sense of taxing payrolls for general revenues.

Colin K writes:


Yes, it's (e) All of the above. As an employer, my payroll service debits my account every time I run payroll, based on the size of that payroll.

Where those dollars go once they leave my bank account is orthogonal--for me, it's a tax on payroll.

In any event, history suggests that taxed dollars go wherever politicians want them to, regardless of whose name taxpayers write on the check. SocSec taxes were used for general expenditures for decades, while the Stimulus bill sent hundreds of billions to pay for state Medicare and UI programs. It's all one big barrel, and we're over it.

Simon K writes:

Don't you have a significant problem if you reduce real wages without also reducing real household expenses? Most households have nominal monthly costs that can be hard to float downwards even in a deflationary environment. Most obviously housing costs, because rents and mortgage repayments are fixed for at least a year in most cases, but also other fixed interest debt eg. car loans.

Any cut in the households real income is magnified by these sticky expenditures, so unless you're very careful these kinds of policies will reduce real household expenditure and saving and thus reduce aggregate demand (or if you think that's too hydraulic, demand for investment goods and household consumables).

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