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

As jobs growth and wage growth show signs of slowing, tax and regulatory changes could help prevent economic pain.

US employment rose 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 policymakers this is good news. The objective of the Federal Reserve’s tough talk on inflation and interest rate hikes is to cool down an overheating US economy. For most Americans, it means inflation will slow down. But the slowdown could mean fewer job opportunities and some pain in the not-so-distant future. Even though job openings remain high, they are also already ticking down.

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

While the rate hikes are necessary, too much monetary tightening could result in a lot of pain on Main Street. As the Fed combats inflation more aggressively, growth will slow further, and the risk of a downturn will increase.

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

Unfortunately, too many government policies restrict competition, punish innovation, reduce labor supply, and even limit the construction of new housing units. This poses a problem because the tax and regulatory environment matters for economic growth.

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

Yet, there’s plenty of evidence supporting how a reduction in income tax coupled with increased sales taxes could encourage people to save, increase labor supply, and boost innovation to expand the economy’s productive capacity and bring down inflation.

To help bring down inflation without much economic pain, the US needs a productivity boost. Improving the tax and regulatory climate at the state level would go a long way to support that effort.

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