The AI Layoff TrapBrett Hemenway Falk, Gerry Tsoukalas∗March 2, 2026AbstractIf AI displaces human workers faster than the economy can reabsorb them, it risks erodingthe very consumer demand firms depend on. We show that knowing this is not enough forfirms to stop it. In a competitive task-based model, demand externalities trap rational firmsin an automation arms race, displacing workers well beyond what is collectively optimal. Theresulting loss harms both workers and firm owners. More competition and “better” AI amplifythe excess; wage adjustments and free entry cannot eliminate it. Neither can capital incometaxes, worker equity participation, universal basic income, upskilling, or Coasian bargaining.Only a Pigouvian automation tax can. The results suggest that policy should address not onlythe aftermath of AI labor displacement but also the competitive incentives that drive it.Keywords: artificial intelligence, automation, labor displacement, Pigouvian tax.1IntroductionThe fear that technology will displace workers is at least as old as the Industrial Revolution (Ricardo,1821; Keynes, 1930; Leontief, 1982).Historically, displacement has largely been self-correcting:automation of existing tasks has been offset by the creation of new tasks and occupations. WhatAcemoglu and Restrepo (2018, 2019) call the reinstatement effect has tended to stabilize the labormarket. Whether this balance will hold in the age of AI is an open question: Autor et al. (2024)find that displacement has intensified over the past four decades while the creation of new workhas not always kept pace, and early signs suggest the current wave is disproportionately affectingentry-level workers (Brynjolfsson et al., 2025a).Even if reinstatement eventually...
