John H. Bishop, a professor at Cornell University's Industrial and Labor Relations School, was co-author of a recent proposal on temporary job-creation tax credit published by the Economic Policy Institute.
Last week, President Obama announced that he was convening a jobs summit meeting, where policy makers would discuss how to reduce the country's high unemployment rate. One idea that has received attention lately "” and which I heartily support "” is a job-creation tax credit, which would make it cheaper for employers to hire new workers.
The federal government has not tried this kind of policy since the 1970s. But the record of that policy gives hope that a temporary tax credit could help solve our unemployment problems today.
Here's how the credit could work, at least according to the proposal I wrote with Timothy Bartik at the Upjohn Institute: Employers would have to expand their payrolls on net to qualify for the credit, in order to prevent companies from simply firing and rehiring people. They would then receive a 15 percent rebate on any increase in their 2010 wage bill over their 2009 level. Firms would also receive a 10 percent rebate for the increase of their 2011 wage bill over the 2009 wage bill.
Based on Daniel Hamermesh's thorough review of econometric research on labor demand, Dr. Bartik and I have estimated that this temporary credit would increase employment by 2.8 million by the end of 2010. We also estimate that it would cost the federal government less than $6,000 per full-time equivalent job.
Assuming these numbers are right, they make the policy an extremely cheap, efficient way to bolster the job market, especially relative to some other proposals, like public works projects. The credit accomplishes so much so quickly because it enables the private sector to figure out which jobs make sense for the long run. Crucial decisions about whom to hire and for what kind of work are not made directly by the government. Rather, they are radically decentralized to the 6.5 million employers who would still pay 85 percent of the cost of taking on a new worker; who select, train and supervise the new hires; and whose vision defines the purpose of their firm's expansion.
A similar two-year temporary credit "“ called the New Jobs Tax Credit "” was established early in 1977, and studies have found it successful.
Firms that increased employment by 2 percent or more in 1977 and 1978 received a New Jobs Tax Credit of about $7,000 (in inflation-adjusted terms) for each additional worker they employed. It took awhile for employers to learn about the credit, but by 1978, most knew of it and one-third were receiving it.
From January 1977 to January 1979, employment rose 11.1 percent, a record-breaking pace for peacetime. Unemployment rates fell nearly 2 percentage points. The chart below plots changes in the employment-population ratio "” the share of the working-age population that has a job "” from 1969 to the present. Notice the recovery stalling out in 1976, the acceleration of growth during 1977-78, when the credit was operating, and the abrupt slowdown in the growth after its expiration.
One particularly impressive part of the policy's track record is that employment did not collapse when the tax credit ended. For 15 months unemployment remained stable, and the employment-population ratio stayed at its up-to-then record level.
The implication of these trends is that eventually, firms were going to start expanding and hiring new workers. The tax credit probably induced some of these employers to expand a little earlier than they otherwise would have, ushering in a faster jobs recovery.
What does the success of the tax credit in 1977-78 imply about the likely impact of a new credit now?
The current pool of underutilized labor and capital is huge, much larger than it was 33 years ago, so we expect the proposed credit for 2010-11 to have a much larger impact on employment.
Now, some might argue that a 15 percent discount on a new hire won't be enough to encourage employers to take on more workers, because companies might still feel demand for their goods and services is too weak to justify expansion.
Where will the demand come from for the products and services the extra workers produce?
We expect demand to come from a few sources: 1) spending by new employees; 2) extra spending by growing firms; 3) abroad; 4) lowered prices causing more real demand; and 5) investments made now rather than later.
Here's how the process would look:
Temporary tax credits for job creation make it cheaper for companies to invest in labor-intensive expansion. It's like putting workers on sale for two years. And the policy imparts a very motivating message to companies: don't wait until after the economy comes roaring back. Hire now the talented people you could not attract in 2007. Get a jump on your competition.
The econometrics work was done in essentially normal time when we could not really argue that there was a hard limit on goods demanded. We could always expect that drops in price would lead to increases in quantity demanded.
Tax credits, which reduce the costs of buying labor move firms down the smooth continuous labor demand curve and improve employment.
Current circumstances seem to indicate that employers are behaving as if there were limits on the total demand for goods and that they are reducing employment to reflect this limited demand.
In these circumstances reductions in employer’s labor costs like reductions in wages cannot be expected to produce great results.
http://wonksanonymous.com/2009/11/16/a-refresher-course-on-labor-markets.aspx
This would be consistent with a situation where the demand for stores of purchasing power - money or other assets - is also not responsive to price. This would be a liquidity trap.
Excellent idea. Cost of administering the tax credit should also be taken into account. The Work Opportunity Tax Credit (WOTC) has been in place for many years. It provides similar, yet targeted benefits to employers.
A significant change is occurring now that wasn’t inplace in the 1970’s. Every aspect of our economy is de-leveraging, more out of credit denial than of choice. Thus I think the benefits would not be nearly as great as Bishop states because dollars from payroll and from tax credits would go to debt payments rather than consumption.
Anything that stands even a remote chance should be tried. At this point, no incentive can possibly make the situation worse for so many Americans.
In the meantime, here’s a satirical look at how we Americans can put all this extra time created by unemployment to good use:
http://bit.ly/ozqT6
(satire)
The work of Daniel Hamermesh (1993) remains the canonical source for estimates of the responsiveness (or elasticity) of employers' demand for labor to changes in labor costs when aggregate output is held constant. After examining nearly 100 studies published in refereed journals he concluded: "The absolute value of the CONSTANT OUTPUT output elasticity of demand for homogeneous labor at a typical firm and for the aggregate economy in the long run is probably bracketed by the interval [0.15, 0.75], with 0.30 being a good best guess" (Hamermesh 1993, 135). This implies that a 10% reduction in labor costs will lead to a 3% increase in employment and hours worked in the economy, even when overall economic output is HELD CONSTANT. He also reviewed studies that examined the timing of responses and concluded that most of the employment response to changes in labor costs occurs "within a year" (p. 294).
If the subsidy of labor costs lowers prices and this increases demand further, THAT EFFECT IS IN ADDITION TO ONE Tim and I simulate.
To edexcel:
I stand corrected. This would imply that employers will substitute labor for other inputs right?
I guess I can see this happening. Maybe people handing out fliers on the street would replace newspaper and TV ads? Maybe more worker effort would result in lower food wastage in a restaruant?
Still a little skeptical.
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