Employer Tax Credit Stimulus to Create New jobs and Lower Unemployment – Good Idea or Bad Policy

The Labor Department reported recently that unemployment reached 9.8 percent in September, the highest level since 1983, and that 10% unemployment is likely by early next year. With record unemployment and a need to ensure the economy doesn’t fall back into a recession, the Obama administration is considering the addition of an employer tax credit to encourage companies to hire more people and create new jobs. The NY times reports that a proposed employer credit is gaining support among legislators and government officials grappling with the highest unemployment (and hence unhappy voters) in a generation. Small business, who are the largest employers in the country, are also firmly behind the idea of this kind of credit. But critics argue that this credit will encourage the creation of false “jobs” and in the longer term do more harm than good.

One version of the tax credit policy under review is to give employers a two-year tax break if they increased the size of their work force (i.e. added jobs) or added significant hours of work (for example, making a part-time worker full time). Employers would receive a credit worth twice the first-year payroll tax for each new hire, amounting to several thousand dollars, depending on the new worker’s salary. The credit in the first year would equal 15.3 percent of the cost of adding an employee. In the second year, it would fall to about 10.2 percent. The policy is intended to encourage companies to start hiring again by making it cheaper to add new workers. Timothy J. Bartik, a senior economist at the Upjohn Institute for Employment Research who is working on the draft with John H. Bishop of Cornell, estimates that it would cost about $20,000 for each job created.

For example, hiring a worker might cost a small business $50,000 annually. But with the tax credit, the cost would fall to $42,350 in the first year, and then be $44,900 the next year. After that, the cost would return to $50,000. The credit would apply only to the portion of an employee’s salary under $106,800. Lowering the cap further, however, could provide an even greater benefit to low-wage, unskilled workers. It is estimated that the credit could encourage the creation of more than two million jobs in the first year.

States have dabbled with similar tax credits in recent years, with mixed results. The federal government last tried this measure in 1977-78. During that period, employment – which had been soft from the 1973-75 recession – climbed at a record pace. One out of three jobs created during that period was attributed directly to the employer tax credit policy. But the permanence of those jobs was less clear, and some dispute how many of those positions would have been created eventually anyway. Supporters say that improvements upon the 1970s policy would increase its potency. These include better publicizing the credit; making it available even to concerns that are not making money, in the form of a direct payout to nonprofits and companies in the red; and distributing the credit quarterly so that companies see it sooner.

Critics of an employer tax credit dismiss the idea as corporate welfare and argue that businesses hire based on actual demand for their products, and a minor subsidy for adding an employee will not make up for the collapse in demand across the broader economy. “Why would a business hire a new worker?” Bill Rys, tax counsel to the National Federation of Independent Business, a small-business industry group, said. “They’re hiring because they need to do work. Unless you have work to do, it’s still an expense.

Even advocates acknowledge that, as with any tax incentive, employers and their accountants will take advantage of loopholes. But they argue that with strong rules — possibly by reducing the credit for “new” companies, or by requiring a company’s overall wage bill to rise along with its work force — the proposal could minimize such abuse. Deficit hawks still worry about the cost of the proposal, and whether it would be politically feasible for Congress to phase it out once businesses have grown used to it.

The biggest fear among some, though, is that the proposal might unintentionally reduce job opportunities if it sits in Washington too long without passing. “Particularly for big employers, if they think a job creation tax credit is in the offing, it could certainly be an incentive to delay hiring,” said Lee E. Ohanian, an economics professor at the University of California, Los Angeles. “That means it could have the perverse effect of actually prolonging the recession.

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