Introduce Temporary Tax Credit for Increases in Payroll
The Administration is proposing a new temporary jobs credit for companies that hire new employees, expand hours, or increase wages in 2010. The credit proposal is not described in the budget documents, but a line item in the budget summary tables (Summary Table S-4, p.151) refers to “allowance for jobs initiatives” that will cost $12 billion in fiscal year 2010, another $33 billion in fiscal years 2011 and 2012, and $5 billion more in fiscal years 2013 and 2014. A White House Fact Sheet describing the proposal estimates the cost at $33 billion.
The jobs credit proposal would give employers a $5,000 tax credit against payroll taxes for net increases in employment of workers earning at least $7,000 in 2010. Employers would also receive an additional 6.2 percent credit (effectively exempting them from the employer share of Social Security payroll taxes) for increases in aggregate wages they pay in excess of inflation to employees making no more than the Social Security taxable maximum of $106,800. In order to limit the subsidy to small businesses, the total amount of credits for any single employer could not exceed $500,000 (enough to provide an incentive to hire 100 additional workers). New firms that had no employees in 2009 would be eligible for half the subsidy that existing firms would receive for increases in employment or wages. Non-profit organizations would be eligible for the credit, but government agencies at all levels would not.
Various provisions would prevent employers from receiving a subsidy for hiring more workers while reducing either total hours or wages. That would preclude, for example, replacing high-wage workers with low-wage workers or substituting more part-time workers for fewer full-time workers. To prevent such abuse, the proposal would make any business that reduces either its total employment or its payroll in 2010 ineligible for the $5,000 credit and the wage bonus and limit the maximum jobs credit amount to 25 percent of the increase in the firm’s Social Security payroll wage base. Other rules would prevent businesses from renaming themselves or merging with other firms to qualify for a credit.
The credit would be based on the difference between average employment and payroll over the entire year 2010 compared with employment and payroll in 2009. But firms could claim the credit in every quarter of 2010 based on their estimated tax benefit for the entire year.
The proposal aims to accelerate the growth in employment as the economy recovers from the deepest economic slump since the great depression. The main way to increase jobs is to raise demand for goods and services, thereby spurring employers to hire new workers or expand hours of current employees to meet the demand. But in addition to raising the demand, the credit would also reduce the cost of labor in 2010, encouraging some firms either to hire more workers permanently or to accelerate hiring into 2010.
Injecting $33 billion into the economy through this additional tax cut for businesses would raise aggregate demand, but its effectiveness in raising demand depends on how quickly beneficiaries spend the tax cut. How much spending increases depends on who benefits from the tax cut. To the extent the credit would go to business owners who would increase employment without the credit, it would simply raise profits. Only new hires or wage increases that would not otherwise have occurred would benefit workers. Because workers generally have lower incomes than business owners, they are likely to spend—rather than save—a higher share of any additional income. The credit would therefore increase demand more if it spurs new employment growth rather than rewarding growth that would otherwise occurred. Higher business profits could, however, raise investments by firms who lack access to affordable credit, but these firms are unlikely to invest more unless there is demand for their products.
Reducing the cost of hiring workers could also raise employment if the lower net wage cost enables to firms to reduce their prices and sell more or if it encourages them to substitute labor for capital in production. The effect of the subsidy on labor cost is fairly modest, however. Recruiting and training costs for new workers are generally high relative to their productivity in the first year on the job, so a one-year subsidy for new workers would be a much smaller share of first year labor costs than its share of the worker’s compensation. Employers typically recover these initial costs if they retain employees longer than one year, but the wage subsidy in the proposal would cease after 2010 and not lower future labor costs.
The purpose of making the credit incremental instead of providing a flat rate subsidy, such as a temporary payroll tax credit for all firms, is to raise the share of credits that provide an incentive for higher employment and wages relative to credits that go to “baseline” wages that would have been paid without an incentive. By reducing subsidies to baseline wages, an incremental credit in theory raises the “bang for the buck” – that is, the amount of additional payroll per dollar of government budgetary cost. But it is impossible to determine what firms would have been done without the credit. An incremental credit fails to provide an incentive for firms with falling demand to reduce their employment less quickly and provides benefits for firms experiencing rising demand that would hire more workers even with no tax incentive. Moreover, an incremental credit would have arbitrary and capricious distributional effects, rewarding firms and workers in expanding industries and regions of the country while failing to help those industries and firms still experiencing economic stagnation.
Limiting the credit to $500,000 per firm effectively limits most of the benefits and all of the incremental incentive to small firms. Other firms and their employees would benefit also, however, to the extent the credit raises aggregate demand and employment through increased spending by those newly employed and business owners with increased profits. But the limit would reduce the cost-effectiveness of the credit, because all firms otherwise increasing jobs by more than 100 workers would receive the full maximum credit without any incentive to hire more workers.
Making the credit available only for 2010 increases in jobs could encourage some firms to hire workers late in 2010 who they otherwise would have hired in 2011. The acceleration of jobs would not directly increase employment in 2011 and beyond, but could indirectly raise jobs in 2011 if the new hires help accelerate the economic recovery by spending some of their increased wages.
Preventing abuse would require complex rules that might, in turn, deter firms from responding to the incentive or lead them only to calculate their eligible benefit after the fact. Evaluations of the 1977 “new jobs tax credit” and how it came about found that most firms were either unaware of the credit or did not respond to it. Research based on a Department of Labor survey found that only 6 percent of firms who knew about the credit said that it prompted them to hire more workers. Firms that were aware of the credit, however, increased employment about 3 percent more than other firms. This may reflect a positive incentive effect or, alternatively that firms who were planning to hire additional workers were more likely to find out about the credit.
Some economists view the 1977 experience favorably and believe an incremental refundable jobs credit that corrects some of the flaws of the 1977 law could be very a cost-effective way of creating new jobs. These analysts, however, criticize the cap on each firm’s increased payroll in the 1977 legislation, which is also a feature of the new proposal.
In summary, the effect of this proposal on employment is very uncertain. In theory, an incremental jobs credit could be a cost-effective way of raising employment in the short run and some research suggests that the 1977 credit did increase jobs, although the evidence on that is far from conclusive. The effectiveness of the subsidy depends greatly on both the details of the proposal, still to be finalized, and on how employers perceive its potential benefits when making hiring decisions.
Will a Jobs Creation Tax Credit Create Jobs and Save Democrats? TaxVox, October 13, 2009
Policies for Increasing Economic Growth and Employment in 2010 and 2011, Congressional Budget Office, January 2010
A Tax Preference is Born: A Legislative History of the New Jobs Tax Credit, Emil M. Sunley, in The Economics of Taxation, Henry J. Aaron and Michael J. Boskin, eds., Washington, DC: The Brookings Institution (1980), pp. 391-408
The New Jobs Tax Credit: An Evaluation of the 1977-78 Wage Subsidy Program, Jeffery M. Perloff and Michael L. Wachter, American Economic Review Vol. 69 No. 2, pp. 173-179, May 1979
The Job Creation Tax Credit, Timothy J. Bartik and John H. Bishop, Economic Policy Institute Briefing Paper #248, October 2009