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New Jobs Tax Credit (From the Archives)

January 15, 2009 by  
Filed under News

Emil Sunley was the Deputy Assistant Secretary for Tax Analysis at Jimmy Carter’s Treasury in 1977. In a 1980 Brookings volume, he recounted the history of this credit, which had morphed into a very complicated and largely ineffective subsidy as it worked its way through the legislative process. It is a cautionary tale for the Obama team and its allies in Congress.

Here is the summary from Sunley’s chapter:

The new jobs tax credit was a product of the legislative process, which has often transformed simple proposals into complex laws. The president’s original proposal was for an optional income tax credit of 4 percent of social security taxes paid by employers. This credit would have had a small anti-inflationary effect in the short run and would have put general revenues into social security through the back door. Congress wanted instead to provide a greater incentive targeted on additional employment, recognizing that the base for any incremental credit must be somewhat arbitrary, as it is not possible to know the number of employees a firm would have had if the credit had not been enacted. The complexity of the jobs credit, which resulted in a number of economic distortions, arose because Congress wanted the credit to be incremental, to do something for the handicapped, and to avoid excessively favorable treatment for new firms that might be competing with old firms. Congress, however, adopted an arbitrary base for its incremental credit. This decision minimized the record-keeping burdens but led to the distortions favoring rapidly growing firms, industries, and regions of the country.

The impact of the credit on jobs was slight. In many firms those who make hiring decisions did not understand the firm’s tax status. In addition, some time passes between the employment decision and the determination of eligibility for the credit.

Because the capital stock is fixed in the short run, to increase employment significantly, demand for output must increase. An incremental tax cut tied to employment will not by itself generate that increase in demand. Moreover, a temporary incremental credit is unlikely to affect significantly the long-run substitution of labor for capital.

The short life of the jobs credit ended when President Carter failed to recommend its extension beyond 1978. Instead he recommended as part of his urban program a targeted jobs credit that was not incremental and was limited to the hiring of disadvantaged young people and the handicapped. Congress generally accepted the president’s recommendations and enacted a targeted jobs credit as part of the Revenue Act of 1978, allowing the former broader jobs credit to expire at the end of 1978 as scheduled.

Source: Henry J. Aaron and Michael J. Boskin, eds., The Economics of Taxation, Washington, DC: Brookings Institution Press, 1980. Reprinted by permission.

The full chapter is available here.

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More on the New Jobs Tax Credit

January 15, 2009 by  
Filed under News

Good to see comments on the New Jobs Tax Credit from two authors of papers on the subject, Timothy J. Bartik of the Upjohn Institute and John H. Bishop of Cornell. In response to my criticism of Barack Obama’s call for an employer credit to encourage hiring, both argue that the Carter-era version of this idea—the 1977-78 New Jobs Tax Credit—succeeded in creating as many as 700,000 new jobs in the first year.

Dr. Bartik has written a book on the subject, and Professor Bishop is the author of several scholarly articles on the credit. Both know far more about this than I. However, after reading two of Bishop’s pieces, an essay by Bartik, as well as an article by Jeffrey Perloff and Michael Wachter and Emil Sunley’s tale of the credit’s rather sad history—which TaxVox posted yesterday—I remain far from convinced that this is a good idea.

One problem is the evidence of success Bishop and Bartik cite is very limited. It is based on two surveys, one by the federal government and the other by a business group, which asked whether companies knew about the credit and whether they increased employment. The results: Those aware of the credit hired 3 percent more than those that didn’t. But Perloff and Wachter, who did the initial research on the plan, warned that these results “should be viewed with caution.” Among the difficulties: the sample was not random, and growing companies were the very ones that had the greatest incentive to learn about the credit. Thus, hiring plans may have driven knowledge about the tax break, rather than the other way around.

In addition, the Carter-era plan was very different from what Obama is talking about. Finally, both men acknowledge the old credit was extremely inefficient: About two-thirds of the jobs it subsidized would have been created anyway. Not much bang-for-the-buck.

There are several challenges to designing a workable credit. As I noted in my original post, businesses losing money (those most likely to be cutting jobs) get no immediate benefit unless the credit is made refundable or is used to offset their payroll taxes—either of which create all kinds of other problems. Also, Bishop concedes that in today’s awful economy a relatively paltry $3000 government subsidy won’t encourage many companies to hire. So he suggests a credit of $6550. This would generate more interest, for sure, but it would also more than double the cost and increase the potential windfall to those businesses that would be hiring anyway.

That brings us to the opportunities to game the system. It happens all the time with business credits. The R&D credit, for example, may do more to encourage companies to shuffle internal costs than increase actual research. The problem, of course, is that the more anti-abuse rules, the less attractive the credit becomes to companies that truly could use it.

It still seems that the easiest way to create jobs is the old fashioned method: Boost demand. I’d rather give the money to people who are going to spend it and let their increased consumption drive the job market.

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