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Issue Brief #3816 on Labor

January 4, 2013

Heritage Employment Report: In December Out with the Old, In with the Same Thing

By and

The December employment report from the Bureau of Labor Statistics (BLS) shows that 2012 ended with an unemployment rate of 7.8 percent and 155,000 new jobs. The labor market has not had an adequate recovery and has made little progress from 2011 to 2012. Many American workers will experience permanent lower lifetime earnings as a result of the poor economic recovery, which has been hampered by bad public policy decisions. This month’s report was simply average, and the longed-for labor market recovery must again wait.

2012 Repeats 2011 in the Labor Market

The average monthly job creation for 2012 was 153,000, which was the same monthly average as 2011 according to the BLS. The unemployment rate fell from 8.3 percent to 7.8 percent over the course of 2012. These are positive strides—albeit slow ones.

That good news is partially offset, however, by a continued decline in the number of people in the labor force. The labor force participation rate fell from 63.7 percent to 63.6 percent, when in a normal recovery the labor force participation should be climbing. The labor force increased by less than 100,000 new workers each month, which is well below average.

The December report was very status quo, with 168,000 new private jobs and 13,000 fewer government jobs. Revisions to previous reports resulted in an upward amount of job creation of 14,000 additional jobs for October and November. Labor force participation and the unemployment rate remained the same as the November report, and the unemployment rate has basically remained at 7.8 percent since September.

The payroll survey had some good news, as the amount of hours worked each week climbed for the second straight month and hourly pay jumped in December. For 2012, average hourly pay increased by 2.1 percent.

Tax Trouble Ahead

Congress and the Administration have charted a policy course that impedes economic growth. All mainstream schools of economic thought—from neoclassical to neo-Keynesian—conclude that raising taxes in a weak economy will depress the economy. The year-end American Taxpayer Relief Act of 2012 will raise taxes for most Americans. Taxes would have risen by more had Congress gone over the “fiscal cliff”; however, relative to existing policy, the year-end tax deal raises rates and will only hurt the economy.

Under the new legislation:

  • Payroll taxes will still rise by 2 percentage points,
  • The top marginal income tax rate will rise by 4.6 percentage points,
  • Taxes on dividends and capital gains will still rise from 15 percent to 23.8 percent, and
  • High-income taxpayers will have their itemized deductions and personal exemptions largely phased out.

Including payroll taxes and state income taxes, and factoring in the phase-out of deductions, this will raise the marginal effective tax rate from 42 percent to 48 percent. In high-income tax jurisdictions like California and New York City, the top effective tax rate will rise to 52 percent.[1]

These tax increases will discourage investment and business start-ups. Investment responds very negatively to taxation. Many individuals would prefer to consume today rather than save. They invest their resources in order to earn a return and consume more in the future.

Raising investment taxes (on capital gains and dividends) encourages consuming today instead of saving. This will reduce investment and raise the cost of capital for business owners seeking to start or expand an enterprise—reducing job creation.

Raising the top marginal rate to approximately 50 percent will further discourage job creation by entrepreneurs. Business owners already in the top bracket will only get to keep half of the money they make if they successfully expand their business. This will reduce their incentive to put the work into and take the risk of attempting to expand.

Fiscal Uncertainty

The threat of more tax increases to come will compound the cost of these tax increases. Many economists had hoped that a fiscal cliff deal would give employers certainty about future tax rates and enable them to plan accordingly. However, the tax deal did nothing to reduce spending and will not put America on a sustainable fiscal path. President Obama has made it clear that he opposes spending cuts and will press for much higher taxes to close the deficit.

Research by Harvard economists shows that countries that try to close large budget deficits by raising taxes usually fail.[2] The economic damage from higher taxes prevents governments from raising the revenues they expected. However, countries that close their deficits by reducing government spending typically succeed—and without harming their economies.

No “Morning in America” for 2013

The employment report for December was apropos for the year. December was a repeat month for the labor market like 2012 was a repeat of 2011. The labor market is recovering very, very slowly with many potential workers not entering the labor force. A full labor recovery is still likely a long way off, especially as public policy will continue to act as a drag to the labor market.

The federal government’s effort to spend our way out of the downturn has proven to be a flop and even worse a hindrance as some policies will now slow hiring and the labor force recovery. As the economy continues to progress, the labor market recovery will continue. Sadly, the pace of the recovery will continue to be weighed down by higher taxes and regulations. The government should not contribute to the economy’s sluggishness. Congress should put America on a sustainable fiscal path by reducing spending instead of hiking taxes.

Rea S. Hederman Jr. is Deputy Director of and Research Fellow in the Center for Data Analysis at The Heritage Foundation. James Sherk is Senior Policy Analyst in Labor Economics in the Center for Data Analysis at The Heritage Foundation.

Show references in this report

[1]Gerald T. Prante and Austin John, “Top Marginal Effective Tax Rates by State and by Source of Income, 2012 Tax Law vs. 2013 Scheduled Tax Law,” Social Science Research Network, November 15, 2012, http://dx.doi.org/10.2139/ssrn.2176526 (accessed January 4, 2013).

[2]Alberto Alesina and Silvia Ardagna, “Large Changes in Fiscal Policy: Taxes versus Spending,” Tax Policy and the Economy, Vol. 24 (2010); Alberto Alesina and Roberto Perotti, “Fiscal Expansions and Adjustments in OECD Countries,” Economic Policy, No. 21 (2005), pp. 207–247; Alberto Alesina, Silvia Ardagna, Roberto Perotti, and Fabio Schiantarelli, “Fiscal Policy, Profits, and Investment,” American Economic Review, Vol. 92, No. 3 (June 2002), pp. 571–589; and Alberto Alesina and Silvia Ardagna, “Tales of Fiscal Adjustment,” Economic Policy, Vol. 13, No. 27 (October 1998), pp. 487–545.

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