In his State of the Union last week, President Obama was unequivocal in pledging to focus on job creation over the next year. To this end, he adjured Congress to produce another economic stimulus-under the moniker of a jobs bill-that will foster an expansion of private hiring.
Although the president was necessarily short on detail, he traveled to the Chesapeake Machine Company in Baltimore on Friday to announce concrete steps in the form of the Small Business Jobs and Wages Tax Cut. Among its salient features, the targeted tax cut includes a $5,000 credit for net new hires in 2010 as well as incentives for increasing the wages of current employees. Up to the taxable maximum of $106,800, wage increases in excess of inflation will be offset dollar for dollar by refunds in payroll taxes. For those businesses that might have expanded payrolls in any case, the program is essentially a tax cut.
By the administration’s estimate, more than one million businesses will take advantage of the tax cut. Open to all firms of all sizes, the cut will cost an estimated $33 billion. In order to focus the benefit of this lost revenue in the hands of small businesses, the credit will be capped at $500,000 per firm. And in consideration of small businesses’ cash flow management, the credit can be claimed quarterly.
The administration’s proposed approach to job creation will find support among labor economists. First, the focus on small businesses is politically and economically appropriate. Anecdotally and statistically, businesses with fewer than 500 employees drive a disproportionate share of payroll growth in the United States. According to the Small Business Administration, small businesses represented just over 50 percent of all private employment and 64 percent of new jobs in the 15-year period between 1993 and 2008. Evidence of the relationship between establishment size and job creation is not as one-sided as the political rhetoric suggests, but the preponderance of research weighs in small businesses’ favor. Combined with an easing of small businesses’ credit constraints-apparently in part from a reassignment of repaid Troubled Asset Relief Program funds-the tax cut will improve the prospects for survival and expansion of small business.
The idea of an employment-related business tax cut is hardly a new idea. But history suggests that careful implementation of the program will prove important for its effectiveness.
A New Jobs Tax Credit was promulgated in the late 1970s in response to a prodding recovery in jobs following that decade’s painful recession. While it is impossible to observe the counter-factual path of job growth in the absence of that program, more than two million workers’ costs were subsidized under its auspices. Various ex-post analyses are inconclusive in assessing the tax credit’s impact. The Congressional Budget Office reports that informational issues may have tempered small businesses’ participation: “The complexity of the New Jobs Tax Credit may have discouraged some firms, especially small ones, from using the credit when making hiring decisions.” More than 30 years later, the cumulative effect of a reduction in payroll taxes is estimated at between 7 and 16 years of full-time-equivalent employment for every $1 million of budgetary costs. The Congressional Budget Office considers it the most effective means of stimulating employment, dollar for dollar, across the many options that it has evaluated.
Even when manifesting as reductions in tax burdens, the administration’s proposals will inevitably draw the ire of some constituency. Friday’s advance estimate of growth in gross domestic product will, in some circles, undercut the case for action on jobs. As the argument goes, jobs will follow economic growth, albeit with a lag. But how many jobs will the economy generate if we meet consensus expectations for growth between 2.5 and 3 percent in 2010?