What is a good business climate for job creation? Changing the conventional wisdom

Most people use some simple principles to guide their judgments about public policy. I think this is quite understandable. Why should we expect most people to spend their time trying to interpret conflicting empirical studies?

As a recent blog post by Digby reminded us, the conventional wisdom is that the only conceivable “job creation policies” are based on “low taxes and regulation”.   As Digby says, “Many people…can’t really see how anything else would work [to create jobs].”

As this blog has outlined in numerous posts, indeed in most of its posts, there are many other policies that can work to create jobs at the state, local, and national levels.   In particular, high-quality early childhood programs have been shown by a great deal of rigorous empirical work to be highly-cost effective in creating additional jobs and earnings opportunities, and can work when implemented on a large scale.

On the other hand, it is difficult to support the other extreme position that taxes and regulation are irrelevant to job creation. There is significant empirical evidence that there is a modest response of new business activity in a state to higher business tax rates, holding public services constant.

How can this somewhat complicated empirical reality be summarized in some simple principles? I would propose the following:  to create jobs and broad-based economic prosperity in your state, local, or national economy, reduce the costs of business job creation while improving your economy’s human capital.

The costs of business job creation are the additional costs associated with some business expansion. These costs can be reduced by services to help facilitate expansion by small and medium sized business. These “marginal costs” of business expansion can also be reduced by lower marginal tax rates on business.  By marginal tax rates, all that I mean are the additional taxes associated with some business location or expansion decision.

By human capital, all I mean are whatever worker skills are associated with being able to be more productive at the workplace. This includes both “hard skills” such as math and reading skills, and “soft skills” such as social skills of working in teams and relating to customers and supervisors.

In sum, to create jobs, low marginal burdens on business job creation and human capital quality should be our guiding principles.

Notice that these principles are silent on the merits of many other policies.  These principles say nothing about income tax rates, for which there is far less evidence that high tax rates on the wealthy have significant economic costs. It says nothing about average business tax rates, as opposed to the tax rate on new job creation and investment. We can have high average business tax rates and low tax rates on new job creation and investment if job creation and investment tax credits are sufficiently generous. These principles also say nothing about government social welfare programs, for which the evidence suggests that there are not huge net negative effects on work incentives.

These many other public policies of course may be important to social well-being.  What tax and welfare system is the fairest?  How progressive should the tax system be? How generous should safety net programs be? All of these are important issues. However, for these other policies, I would argue that their impact on job creation is a secondary concern.

Job creation and earnings creation also depend on luck. For example, a great deal of the short-term and medium-term economic fortunes of a state or local economy depends on how demand for the area’s main industries is growing in the global economy.

But some public policies can significantly affect job creation. The public policies that have the biggest bang for the buck in driving job creation are lowering costs for job creation, and making large-scale and cost-effective investments in human capital.

The current conventional wisdom errs in assuming that the plausible positive impacts of lower marginal business tax rates means that all tax rate cuts are a cost-effective way of encouraging job creation. The current conventional wisdom also errs in ignoring the importance of worker skills in creating additional jobs and earnings. And creating such worker skills requires a tax system that raises the revenue needed to support the large scale creation of better worker skills. High-quality education and job training is not cheap.

On the other hand, advocates for a more redistributional tax and welfare system should realize that such a system can only be sustained if there is sufficient emphasis on encouraging jobs and earnings creation.  As economic historian Peter Lindert has argued, economic and political systems with strong social welfare components have been best able to be economically sustained if they also pay attention to marginal cost burdens on business, as well as on making sure that the public spending mix emphasizes services that boost productivity.  We also need to make sure that our investments in human capital are organized to be as effective as possible.

This new conventional wisdom, of creating broad-based prosperity through lowering costs for job creation and increasing worker skills, can also be framed as an issue of fairness. Isn’t it fairer to focus more public resources on those businesses that actually create jobs, as opposed to across the board tax cuts? Isn’t it fairer to focus more public resources on helping people develop skills that will benefit the entire economy? There are huge social spillover benefits both of business job creation, and of higher worker skills.

I don’t know exactly how the “conventional wisdom” is changed. But our future as a society rests on whether there is broad public understanding of the best paths to greater economic prosperity.

About timbartik

Tim Bartik is a senior economist at the Upjohn Institute for Employment Research, a non-profit and non-partisan research organization in Kalamazoo, Michigan. His research specializes in state and local economic development policies and local labor markets.
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