Faced with a jobs crisis, policymakers the world over are digging deep into their policy toolkits to generate more employment. A recent study by the IMF’s Fiscal Affairs Department argues that reforms of tax and expenditure policies offer great promise in helping countries confront the jobs crisis, including in the short term.
The study argues that improving employment outcomes, over and above what could be achieved through policies aimed at supporting the demand for goods and services by consumers and investors, requires actively supporting labor demand, strengthening incentives (or reducing disincentives) to work, and expanding training and job assistance, while preserving equity objectives.
The labor market challenge
The economic and social consequences of job losses since the onset of the global crisis have been enormous. However, as bad as the crisis has been for jobs, unemployment was already elevated before the crisis in many advanced and emerging economies. This would suggest that labor market challenges will not go away as the global economy recovers, and that policy measures are needed both to address structural employment issues and to improve the employment outlook in the short term.
Three labor market challenges are particularly important: high rates of long-term unemployment—that is, unemployment lasting more than one year—which is often much higher than short-term unemployment, particularly when compared to Northern European countries that have effectively managed to contain long-term unemployment (Chart 1); high rates of youth unemployment—that is, unemployment among those aged 15–24—which stand at over 50 percent in Greece and Spain and close to three times the overall unemployment rate in a number of economies (Chart 2); and high unemployment rates for unskilled labor, which are much higher than those for skilled labor.
In addition to having a large number of people without a job but searching for one, many countries also have a large share of the working-age population that is no longer looking for employment and thus not participating in the labor market.
Non-participation may reflect cultural preferences or being discouraged from seeking work by weak job prospects or a lack of financial incentives. Raising labor force participation over the medium term can help spur economic growth and contribute to fiscal consolidation by expanding the tax base.
Policy design matters
Fiscal policy matters for employment—both in the short term and the medium term.
There are several options to improve the design of taxes and benefits that can help boost employment without hurting equity. We see four areas of potential reform:
- Tax wedges. Cutting the “tax wedge,” that is, the amount of tax as a proportion of take-home pay, works best when targeted to groups that are most responsive to financial incentives: women, workers close to retirement, and the low-skilled. For example, low-skilled workers could be encouraged to work by receiving tax credits that increase their take-home pay. Reducing the tax wedge falling on the income of the secondary earner in a two-income family could encourage both spouses to work. In the short run, lower employer social insurance contributions, targeted to low-wage earners, can be effective in stimulating job creation. More progressive tax schedules (that is, tax schedules where the tax burden rises in percent of income as incomes go up), could also be considered as a revenue-neutral reform that reduces tax wedges for low-skilled workers.
- Unemployment benefits. Tougher job search requirements for recipients of unemployment benefits, combined with intensive monitoring and appropriate sanctions, have been successful in reducing the length of unemployment spells. In particular, where the receipt of benefits has been made conditional on participation in “active labor market” programs (see below), exit rates out of unemployment have increased considerably.
- Active labor market programs. These programs can reduce unemployment by better matching those seeking work with job vacancies. They are most effective if targeted at the young and long-term unemployed. For example, subsidized on-the-job training and apprenticeships have been successful in smoothing the transition of youth from school to work. Targeted wage subsidies have been effective in generating jobs for the long-term unemployed and unskilled. A key lesson, however, is that, beyond targeted and time-limited interventions, merely providing more public sector jobs is generally ineffective in improving employment outcomes.
- Pension systems. Older workers could be encouraged to work longer if their future pension benefits were adjusted fully for extra years of contribution, eliminating the financial incentive to retire early.
Some may argue that the policies we recommend to increase labor force participation would be harmful, rather than helpful—don’t the high levels of unemployment we see now mean that there are already too few jobs?
The answer is timing—first of all, measures to foster higher labor-force participation will take more time to yield fruit than measures aimed at boosting demand or at improving matching. Further, over the longer-term, higher labor force participation rates, including for older workers, have been shown not to increase unemployment, but rather to be correlated with higher total employment through economic growth.
No time for delay
The appropriate reform mix differs across countries. It will need to be adapted to, and appropriately sequenced for, each country’s employment challenges, labor market institutions, and fiscal constraints. An immediate priority for countries where unemployment has risen sharply is to restore labor demand and to implement active labor market programs that help match labor supply and demand.
Beginning reforms to increase labor force participation, likewise, should not be delayed, given their longer gestation period. Now is the right time to implement structural reforms to tackle the employment crisis and to stimulate the demand for labor—and the design of policies matters very much for labor market outcomes.