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Business confidence is a well-known leading indicator of future output, especially during economic downturns, and receives attention from the media, policymakers and forecasters. Somewhat surprisingly, the direct link between business confidence and investment has not yet been investigated. Our paper fills this gap. We provide a quantitative assessment of the information in business confidence for future investment growth, after controlling for the conventional determinants such as user cost, output, cash flow and stock price.

Understanding the predictive power of business confidence is valuable along three dimensions. First, it can help forecasters and policymakers improve their investment forecasts. Second, it can provide a rationale for explicitly including business confidence—either as causal or as anticipatory—in theoretical models of business cycles. Third, it can help motivate studies on the how investment managers’ social and psychological circumstances influence investment decisions over and beyond rational cost-benefit analyses.

Business confidence is an important indicator because it affects the economy. For example, it influences a business’s decision to invest. If businesses are optimistic, we expect them to invest more in capital goods. An increase in investment increases aggregate demand, pushing the curve to the right. As a result, the economy grows higher and produces more output.

In addition to investing in capital goods, businesses increase recruitment to increase output. Thus, the unemployment rate also falls because there are more jobs available. Finally, higher economic growth improves household income and employment prospects.

The idea that changes in consumer and business confidence can be important business cycle drivers is an old but controversial idea in macroeconomics. It assumes that confidence reacts not only to movements in economic fundamentals but is itself an independent cause of economic fluctuations distinct from those fundamentals. In recent decades, cycles of boom and bust in Japan, East Asia, and the United States have focused renewed attention on the question of confidence. These experiences suggest that optimism about the future helped fuel economic booms and that subsequent buildups of pessimism contributed to the busts. Moreover, these episodes fostered intense debate about the role of monetary policy in boom-and-bust cycles. Central banks have been sharply criticized for stoking the booms and inflating confidence by setting excessively accommodative monetary policy.

This Economic Letter considers the role of confidence in macroeconomic models. Specifically, the Letter examines professional economic forecasts to investigate whether relative optimism and pessimism—that is, expectations that good or bad times are ahead—may be important business cycle drivers. It also analyzes how monetary policy responds to buildups of confidence.

When consumers feel more confident about the future of the economy, they tend to consume more. If business confidence is high, then firms tend to spend more on investment, believing that the future payoff from that investment will be substantial. Conversely, if consumer or business confidence drops, then consumption and investment spending decline.

The University of Michigan publishes a survey of consumer confidence and constructs an index of consumer confidence each month. The survey results are then reported at http://www.sca.isr.umich.edu, which break down the change in consumer confidence among different income levels. According to that index, consumer confidence averaged around 90 prior to the Great Recession, and then it fell to below 60 in late 2008, which was the lowest it had been since 1980. Since then, confidence has climbed from a 2011 low of 55.8 back to a level in the low 80s, which is considered close to being considered a healthy state.

The baby boomers are hitting their retirement years, and that may make it more challenging — and economically costly — to lower inflation.

Why it matters: With retirements driving slow labor force growth, more of the burden of bringing inflation down will fall on the Fed's efforts to reduce demand — meaning a more severe downturn than might occur otherwise.

Job lock may result from circumstances in which an individual would prefer to retire but continues working in order to obtain employer-provided health insurance coverage. In their review of the health insurance and retirement literature, Gruber and Madrian (2004) found solid empirical support across multiple studies that health insurance affects retirement decisions. Specifically, they reported that the availability of health insurance after one has retired (i.e., retiree health insurance) increases the odds of retirement by 30–80%. These findings were consistent across various empirical methods, models, and datasets. Older workers, and particularly those who are less healthy or more in need of healthcare, may be less willing to retire from a job that offers health insurance if insurance would otherwise not be available, be very expensive, or offer less coverage. Prior to the U.S. Affordable Care Act of 2010 (ACA) and recent changes to U.S. health insurance policy, 90% of individuals with private health insurance obtained coverage through their employment or employment of a family member (Gruber & Madrian, 2004). One of the provisions of the ACA was to require that employers make policies available to their workers.

In the U.S., age 65 is significant because it is the age when all Americans become eligible for health insurance through Medicare. This has implications for health insurance-related job lock. For example, Cutler (2002) studied older workers in the U.S. who were financially and psychologically ready to retire but remained employed in order to retain employer-provided health insurance until reaching the age of eligibility for Medicare. A review of this literature concluded that health insurance is indeed an important factor related to whether and when individuals retire, especially for secondary earners (who are predominantly married women; Fisher et al., 2016; Gruber & Madrian, 2004; Murasko, 2008). Specifically, this research has found that among households with dual earners, one spouse may work primarily to obtain employer-provided health insurance or supplementary insurance for the household. Relevant to the aims of the present study, they also found that there was very little research on the welfare effects of this outcome (Gruber & Madrian, 2002). Rashad and Sarpon (2008) conducted a literature review and concluded that there is evidence of health-insurance related job lock in the U.S. They presented empirical results using data from the National Health Interview Survey (NHIS) to study individuals with health insurance in which they compared those with and without employer-provided health insurance. Individuals with employer-provided health insurance were less likely to leave a job and more likely to stay on the job longer than those with other sources of health insurance. Boyle and Lahey (2010) found that new access to non-employer provided health insurance decreases full-time work and increases part-time employment among older workers. More research is needed to build our understanding of employer-provided health insurance and labor mobility, particularly given the passage of the ACA.

The key difference between the two plans is the minimum wage for the new jobs. The Tcherneva plan establishes a $15 minimum wage and the Paul et al. plan calls for an $11.80 minimum wage for all federally guaranteed jobs. Yet, both have the same underlying goal: Permanently solve the problem of involuntary unemployment by making the federal government the employer of last resort.

A federal job guarantee would be monumentally expensive, return only limited value from the participants’ work, entail administrative challenges nearly impossible to solve, and be potentially disastrous for economic growth and the private labor market.

Relying on rigorous but basic economics and data analysis, we find the following:

#3: It could crowd out tens of millions of private sector jobs. There are currently 54 million people who earn $15 an hour or less. When they find out the federal government is offering $15 an hour plus benefits and permanent job security, many of those workers would quit their current job and join the federal workforce.3 Companies that could afford to would raise wages to keep some of these workers; other companies would simply go out of business. The labor markets would be controlled by the government in ways never seen before in America. And even if just half of low-wage private sector workers quit, the number of federal employees would rise by between 35 and 40 million.4 Costs to the government would then rise to anywhere from $1.6 trillion to $2.24 trillion per year, and the private sector would see massive repercussions.

#4: Inflation would rise. A sudden increase in the cost of labor for businesses will lead to inflation throughout the economy because of higher business costs that will need to be passed on to consumers. In addition, when only those at the bottom of the income distribution get a defacto raise to $15, there are upstream consequences. Workers who were making $15 an hour may demand $20 an hour now. Workers making $20 an hour might want $25 an hour and so on. This may seem like a benefit, but “this is a story of serious wage-price spiral, unless we introduce other measures,” warns progressive economist Dean Baker.5 We have been very fortunate that inflation has been well under control for the last few decades. A federal jobs guarantee could change that pretty quickly.

Sanders wants the government to provide guaranteed jobs at $15 an hour, plus benefits. His office did not, a representative demurely told Post reporter Jeff Stein, yet have cost estimates for this proposal.

Perhaps we can help the senator out. With two weeks of paid vacation, each worker would make roughly $31,000 a year. Add, conservatively, about $10,000 for benefits, and the total cost would be about $40,000.

A first question is how much to pay. A program of last-resort employment could likely provide the minimum wage and low benefits. But that will not help those laid off from highly paid manufacturing jobs or those who expect to earn wages well above the poverty line. While such a proposal could help many young people, it is far from clear that it would connect with the principal concerns of Rust Belt adults.

On the other hand, if the guaranteed jobs paid premium wages, say double the $7.25 per hour national minimum wage, they would be an attractive alternative for a quarter or more of the workforce, raising questions of cost and economic disruption.

The costs, too, are daunting. Both the CBPP and LEI reports project costs ranging from $450 billion to more than $600 billion, which put the proposed programs in the same league with the Pentagon in terms of discretionary spending.

And while it is true that the cost of any of the federal jobs guarantee programs would be offset by savings in current unemployment insurance and poverty mitigation programs, neither of the estimates include costs of designing, staffing, and managing the proposed agency.

But there’s a very good chance that the politics of the modern day would turn a job guarantee into something very different from the New Deal -- and make it much less beneficial for the economy.

First, there’s the question of whether people could be fired from the new program. It’s easy to imagine good reasons to fire someone from a government job -- starting fights, for example, engaging in criminal activities or simply refusing to work. Even if a job guarantee allowed workers to be fired for egregious offenses, there would doubtless be intense public scrutiny of firing decisions, especially on social media. That would put immense pressure on the administrators of the federal jobs program to avoid firing even those who deserved to be fired.

The progressive income tax system is designed to reduce the tax burden of those with a lower ability to pay and shift the burden increasingly to those with a higher ability to pay. Thus, it is commonly believed that an increase in tax progressivity will shift the burden of taxation from the poor to the rich. While most experts agree that higher progressivity reduces economic growth, they remain divided as to whether tax progressivity reduces inequality or even have any effect on inequality whatsoever. On one hand, some researchers found that by discouraging human capital investments, tax progressivity leads to higher inequality. Caucutt et al. (2003) show that reductions in the progressivity of labor income tax can positively affect growth and, furthermore, that “a less progressive tax system, which is rarely perceived as an egalitarian measure, gives rise to increased growth, decreased inequality, and greater mobility for the poor in the long run.” This mobility up the ladder of success is caused by the increased incentive for human capital accumulation.7 Meanwhile, Heathcote, Storesletten and Violante (2010) find that even if a progressive tax succeeds in reducing inequality, such policies can have a negative effect on welfare. For example, more progressive taxation dissuades individuals from acquiring additional education more than under a flat tax. This is because the expected income increase due to additional education would be taxed less, and therefore more valuable.8 Gimenez and Pijoan-Mas (2006) find that more progressive tax reform reduces economic output by 2.6 percent but results in a more egalitarian after-tax income distribution.9 Ventura (1999) also concludes that changes from tax progressivity to a flat-tax regime can bring about large gains in output and productivity at the expense of significant increases in inequality.10 Erosa and Korkeshova (2007) find that although progressive income taxes can reduce inequality, they have a negative effect on output.11 Others have found that tax policy has little impact on inequality. Sarte (1997) highlights that since individuals are endowed with different rates of impatience, they face a different rate of return on both human and physical capital leading to income dispersion. It is because individuals have different rates of impatience that some states are more unequal than others and not necessarily because of their tax regime. As a result, higher top marginal tax rates seem more effective at reducing economic growth than at reducing the degree of long-run income inequality.

The distance between America’s rich and the poor has grown in recent years—Berkeley economist Emmanuel Saez, for instance, finds that average real incomes for the top 1 percent of US earners grew by 80 percent from 1993 to 2014, compared to less than 11 percent growth for everyone else. US presidential hopefuls, eager to find solutions to a problem that frustrates many, hawk policies designed to shrink the gap—among them, raising taxes on the wealthy.

But under certain circumstances, hiking taxes might actually exacerbate inequality, according to research by two Chicago Booth economists. Lubos Pastor and Pietro Veronesi built a theoretical model suggesting that as tax rates rise from zero, income inequality and the level of stock prices initially rise with them before eventually falling. Their model also predicts that higher tax rates make the economy smaller but more productive.

No one planned it this way, but business taxes are going up just as the economy faces the risk of going into a recession. A combination of tax increases pushed through by Democrats, as well as ones created by Republicans years ago, would add to the strain on employers’ finances if a downturn hits, as some economists are predicting. Altogether, the hikes — which range from a brand new corporate minimum tax to restrictions on some key deductions — are projected to cost businesses more than $100 billion this year, which is about one-quarter of their total tax bill for 2022. Lawmakers are facing demands from the business community to rescind the provisions, which will grow louder if the economy continues to weaken. The prospect of Washington doing anything about them or anything else to help growth seems dim, though, with Congress under divided control and House Republicans hardly demonstrating unity in the early going. “This is a particularly challenging moment in time,” said Chris Netram, managing vice president for tax at the National Association of Manufacturers. “If you layer on tax increases on top of a slowing economy, what does that do for business? It puts our guys in a bind.” It’s the exact opposite of what usually happens when bad times hit. Normally, lawmakers turn to the tax system to help cushion the blow for both individuals and employers, by finding ways to lower taxes. In the initial wake of the coronavirus pandemic, lawmakers sent checks to millions of Americans, among other changes, while making it easier for businesses to qualify for refunds. Business advocates had hoped lawmakers would turn off at least some of the hikes during last month’s lame duck session of Congress, though that fell apart over a partisan dispute over Democrats’ demands to also expand the Child Tax Credit.

For small businesses, taxes are a financial and administrative burden that directly impacts their ability to invest in their business, their employees, and compete in the broader economy. In fact, 77% of small business owners reported that federal business income taxes were very or moderately burdensome according to NFIB’s 2021 Tax Survey. This was followed by payroll taxes (69%) and state and local income taxes (66%). The survey also found that 64% of small business owners reported that federal business income taxes create an administrative burden in operating their business. Payroll taxes (60%) and state and local income taxes (58%) followed.[1]

Tax related issues also rank high among small business problems. Of the top ten most burdensome problems small business owners report, four are tax related. At the top of the tax list, federal taxes on business income ranked as the third most severe problem, with 20% reporting it as a critical issue. Property taxes followed in fourth place, state taxes on business income ranked seventh, and tax complexity ranked eighth in problem importance.[2]

Taxes. Almost no other word injects as much fear into the hearts and minds of small business owners than this one—no exaggeration. According to score.org, 40% of small business owners say taxes and bookkeeping are the worst parts of business ownership. Considering that 99.9% of all U.S. businesses are small businesses, that adds up to a lot of dread.

But is that sense of fear and dread well-founded? Consider this—even the federal government knows there are problems with compliance. According to the U.S Senate Committee on Small Business & Entrepreneurship “small businesses spend 2.5 billion hours complying with IRS rules each year. For entrepreneurs, time is one of their most valuable resources. Every hour spent filling out forms or navigating confusing tax rules is an hour they don’t spend marketing their products or thinking about how to grow their business.”

Due to the COVID-19 pandemic and the war in Ukraine, governments around the world are struggling with expanding debt levels. In Germany, for example, the debt to GDP ratio increased by more than 10 percentage points from 2019 to 2021 , not yet including the economic impact of the war in Ukraine. As debt rises, governments are facing increasing pressure to create further fiscal revenues. Key proposals to do so are raising taxes for individuals (e.g. Ayaz et al. 2022) or for firms.

However, raising taxes creates a trade-off: while in the short term, higher taxes may lead to additional tax revenues, it may also reduce investment and therefore inhibit economic growth, resulting in lower tax revenues in the long term. While the theoretical predictions on this effect of taxes on investment are clear (Hall and Jorgenson, 1967), empirical evidence is still scarce.

The idea that the agenda of Joe Biden would be positive for the economy is taken to mean that his plan to increase taxes would also be positive for the economy. However, it is a mistake to think the corporate or individual income taxes can be raised without negative effects. His campaign recently told the , “Tax increases now would accelerate growth by funding a stream of spending proposals that would help the economy.” So the argument seems to go that because higher tax rates could fund new programs, higher tax rates would help the economy. But as noted by Douglas Holtz Eakin, “The taxes are bad but all the better news for growth, if there is any, is in the spending proposals.” That means tax increases on business and higher earners would inflict damage on the economy no matter how the revenue would be spent. In fact, all major analyses of the tax plan of Biden find negative effects on the economy. Estimates from the Tax Foundation model show that his tax plan would reduce productivity output by nearly 1.5 percent over the long term. The magnitude varies across estimates due to different factors, like how open the economy is, but the direction does not. The proposal from Biden to raise taxes does not look strong considering the fragile . Imagine if his administration will enact a corporate income tax rate increase with Congress next year. It would hit companies as they are starting to come out of the coronavirus recession. It would make investment and hiring plans less viable. As a result of that tax increase, companies would be and would face a higher cost of investing in the United States. Not only would this discourage investment for a nascent economic recovery when more investment is needed, it would also burden workers. Estimates show that half the burden of the corporate tax increase would rest on workers over the long term. The Congressional Budget Office assumes a fourth of the burden of the corporate income tax falls on workers. While his advisers are encouraging Biden not to wait to increase taxes because the associated spending will bolster the economy, others are doubting the wisdom of tax increases when our growth is the goal. As Michael Strain notes in , “Tax increases would slow growth or leave it relatively unchanged. Why use any capital on those policies that will not speed up the economic recovery?” The notion that tax increases are positive for the economy is false. Hiking the marginal tax rates on labor or capital will reduce the incentive to work or save even if the higher revenue will be used well. There are other ways to raise a dollar of revenue for any given purpose. That reality is obscured when we focus on these effects of taxes and spending.