Fiscal impetus and the U.S. labor market

Putnam Fixed Income Team, 05/13/21


  • President Biden is transforming the fiscal policy landscape with multi-trillion-dollar spending plans.
  • The U.S. labor force has shrunk compared with other countries with similar benefit structures.
  • There are signs that corporate profitability may have peaked amid rising input costs.
April was a busy month on the U.S. fiscal policy front. In late April, the Biden administration rolled out a $1.8 trillion spending and tax plan to bolster the social safety net in the United States. The proposed American Families Plan follows the $2.3 trillion American Jobs Plan introduced in March and the $1.9 trillion American Rescue Plan in January. We examine the interplay between the various fiscal plans, the labor market, and corporate profits.

The hefty price tags on Biden’s plans

Biden’s “human infrastructure” agenda — the American Families Plan — includes $1 trillion in new spending and $800 billion in tax credits over 10 years. This will be Biden’s third in a series of proposals to overhaul the economy, and a sizeable portion of it extends the American Rescue Plan. The tax credits in the proposed program include stretching the child tax credit through 2025 and making permanent the expanded earned income tax credit, child and dependent care tax credit, and other tax credits. Extending the child tax credit could have — on the margin — a negative impact on the U.S. labor supply. On the other hand, we think the earned income tax credit is a well-designed program that has the potential to encourage more people to participate in the labor market.

Many spending provisions are aimed at expanding access to education and child care, including universal prekindergarten, and paid family and medical leave. The proposal for free community college for all can add to long-term consumption and GDP growth as well as inflation, we believe. The White House has proposed $1.5 trillion in tax increases over 10 years to finance much of the plan. If the “human infrastructure” plan is passed without any changes, it is likely to increase the U.S. debt burden.

Disincentives to work?

As the government’s role in the economy rises, its influence on economic variables increases. Some features of the pandemic fiscal packages seem to be adding to labor shortages and wage inflation by discouraging workers from actively participating in the labor market. It is not just the expansion of unemployment benefit programs that have reduced the incentive to work.

If the government has been providing unconditional financial aid, the second earners’ willingness to participate in the labor market declines. We believe this is largely because the pandemic has increased the burden on workers by causing additional responsibilities and chores at home.

While the changes in the benefit amounts and the coverage of unemployment programs can keep people in the labor market “on paper,” stimulus checks and some features of the recently announced American Families Plan may encourage some people to leave the labor force altogether. The U.S. labor participation rate dropped with the mobility restrictions and has not moved much since then compared with many countries with similar benefit structures. This is especially significant because the United States is far ahead with re-opening parts of its economy.

In addition, we note that in many European countries, the governments have paid corporations directly to keep employees on payrolls. The participation rates in these countries are therefore artificially high. The U.S. has a similar but less comprehensive program called the Paycheck Protection Program (PPP) for small businesses. Many features of this program are set to expire on May 31. This can have negative consequences on May or June payrolls.

Assessing company profitability

Inflation tends to be a late-cycle phenomenon. As companies try to meet demand by increasing the utilization of labor and capital, they typically increase the prices of labor and capital. But many businesses cannot raise prices to keep pace with rising cost. We attribute this to households’ propensity to save. As the working-age population gets older, the desire to save rises, making them more price sensitive, in our view.

This is another way of saying the corporate sector lacks pricing power. Can the pandemic recession, which has been accommodated by extremely loose fiscal and monetary policies change this dynamic? Can the corporate sector raise the prices of goods and services to maintain their profit margins? The evidence so far indicates that U.S. businesses were able to pass through only a portion of the increase in input costs.

The gap between input prices and prices charged has been widening for months. While large multinational companies might have room to reallocate activity across regions to reduce the cost burden, many small businesses likely do not have these capabilities. Recent surveys of small businesses by the National Federation of Independent Business (NFIB) point to a decline in profits. While price expectations have been rising, sales expectations have been declining in real terms. We believe the next few months will be critical. Corporate profitability may have peaked if things remain the same.

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