Chicago economy

Cooling an overheated US economy doesn’t have to be painful

As job growth and wage growth show signs of slowing, tax and regulatory changes could help stave off economic hardship.

US employment increased by 390,000 in May. Job growth is slowing. Price and wage inflation are also showing signs of slowing, according to the same government data.

For policy makers, this is good news. The goal of the Federal Reserve’s tough rhetoric on inflation and interest rate hikes is to calm an overheated US economy. For most Americans, that means inflation will slow. But the slowdown could mean fewer job opportunities and pain in the not-too-distant future. Even though job vacancies remain high, they are also already declining.

To cool an overheated US economy, the Fed will have to raise rates further.

While rate hikes are needed, too much monetary tightening could cause a lot of pain on Main Street. As the Fed fights inflation more aggressively, growth will slow further and downside risk will increase.

Since supply-side constraints are part of the inflation problem, there is much that state and local governments can do to help put the U.S. economy on a path of sustainable growth.

Unfortunately, too many government policies restrict competition, penalize innovation, reduce the supply of labor and even limit the construction of new housing. This is problematic because the fiscal and regulatory environment is important for economic growth.

Take Illinois, for example. Illinois has the 36e worst business tax climate of any state, according to the Tax Foundation, and the tax burden facing Illinois is the highest in the nation. Illinois is also among the most regulated states in the country.

Yet there is plenty of evidence to show that a reduction in income tax coupled with an increase in sales taxes could encourage people to save, increase labor supply and spur innovation for increase the productive capacity of the economy and reduce inflation.

To help reduce inflation without too much economic hardship, the United States needs a productivity boost. Improving the fiscal and regulatory climate at the state level would go a long way to supporting this effort.