New Jobs Tax Credit (From the Archives)

By :: January 9th, 2009

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.

19Comments

  1. Anonymous  ::  3:11 pm on January 9th, 2009:

    Summary of Research on Impacts of the 1977-78 NJTC
    In 1977 and 1978 firms that increased employment by at least 2 percent received a tax credit of 50% of the increase in each employer’s FUTA wage base (sum of wages paid up to $4200 per employee) under the Federal Unemployment Tax Act above 102 percent of the previous year’s FUTA wage base. The marginal wage and salary cost of employing additional non-supervisory workers at an existing firm (earning the mean weekly wage) was reduced by 21 percent. The net after tax cost of hiring additional part time workers and minimum wage workers was reduced by more than 40 percent.
    The NJTC was not signed into law until June 1977 and the Treasury and other public agencies did little to publicize and promote it. Consequently many small employers were not aware that expanding employment would reduce their tax liability. A National Federation of Independent Business survey found that only 43 percent of their members knew of the credit in January 1978.
    By July 1978, 68 percent were aware of the credit and 4.1 percent said they had increased employment (by an average of 2.3 workers) in part because of it. If these NFIB respondents are representative, multiplying these figures by 3.5 million (the total number of employers in 1977), produces an estimate for July 1978 of about 300,000 extra jobs created as a result of the NJTC (McKevitt 1978).
    A Bureau of the Census survey of a stratified random sample of firms achieved a much higher response rate than the NFIB survey. The Census survey’s estimate of employer awareness of the NJTC and of the response to it were also larger. Perloff and Wachter (1979) used the Census data to compare the rates of employment growth in 1976 and 1977 of firms that knew about the credit and those that did not. Controlling for sales growth and other firm characteristics, they found that the employment of the firms that had already heard of the credit had grown three percent faster in the preceding year than at the firms that were unaware of it. If you multiply the 3 percent figure by employment at small firms that knew about the credit, the total number of extra jobs in February 1978 was roughly 700,000. Since NJTC passed Congress only 9 months before, this would be an impressive number. Perloff and Wachter viewed their results “as an upper bound on the short run impact of the program” because some of the firms may have learned about the credit because they were growing rapidly.
    Another source of uncertainty about the size of the aggregate stimulus comes from the knock-on effects of one firm’s expansion on suppliers, distributors and competitors and the effect of reduced marginal costs on pricing and sales. Many of these displacement effects are netted out when industries (not firms) are the units of observation, so interrupted time series studies of industry employment are potentially informative. Bishop and Haveman’s time series analysis of employment in construction and distribution industries from 1952 through the third quarter of 1978 concluded that employment growth had accelerated during the 15 month period following the passage of the New Jobs Tax Credit legislation (Bishop 1981, Bishop and Havemen 1979).
    Consistent with theory, NJTC’s ‘impacts were larger for part-time jobs than full-time jobs. Hours worked per week in retailing fell in 1978. Theory predicts that a temporary marginal employment subsidy should lower marginal costs and increase price competition. Bishop (1981) found that margins between retail and wholesale prices in restaurants and other labor intensive retail sectors were declining during 1977-78.
    Private employment grew by 7.4 million jobs or 11.1 percent during the 24 month period (December 1976 to December 1978) the NJTC was in effect. Only entry into World War 2 and Korea and demobilization after WW2 have generated larger 24 month rates of private job growth. Industries not eligible for the NJTC—government and private colleges and universities– grew at significantly lower rates during 1977 and 1978.
    Growth was particularly rapid in industries with many small firms: 18 percent in construction, 10.9 percent in retail trade, 10.8 percent in professional and business services and 11.2 percent in physicians offices. A limitation of $100,000 on the amount of the credit any one firm could receive reduced its incentive effects for very large firms. Consistent with that hypothesis, growth rates in 1977 and 1978 were lower in industries dominated by large firms–6.6 percent for utilities and 8 percent for manufacturing.
    The unemployment rate which had stagnated between 7.6 and 7.9 percent in 1976 dropped two percentage points to 5.9 percent in the final quarter of 1978.
    What happened after the NJTC expired in December 1978? The growth of private employment slowed to 1.8 percent during the next six months and then stopped altogether. By the third quarter of 1980, the unemployment rate had returned to its 1976 level of 7.7 percent. Was this due in part to an unwinding of the NJTC’s employment stimulus?
    Possibly, but we will never know because the American economy experienced two huge shocks—a doubling of oil prices (after the February 1979 Iranian Revolution) and the Federal Reserve’s adoption of a tight monetary policy on October 1979—that would defeat any effort to tease out the effect of a NJTC phase out. Unemployment reached 10.6 percent in the fourth quarter of 1982.
    Overall, about 1.1 million of the nation’s 3.5 million employers (probably more than half of profitable eligible firms) claimed a credit on their 1978 return. The face value of the 1978 credits claimed was $4.513 billion for a net cost of roughly $3.1 billion dollars (a 0.69 percent reduction in federal tax revenue in 1978) or about 0.13 percent of GDP in that year.
    Extrapolating from Bishop (1981) and Perloff and Wachter (1979), the NJTC probably generated at least a million jobs by the end of 1978.
    The average earnings of non-supervisory workers was $10,946, so adding a million jobs would have increased total labor compensation (including fringe benefits, pension contributions and the employer share of SSA taxes) by roughly 13.5 billion dollars. That would make the first-round bang-for-buck about 4.35 to 1. If the marginal propensity to consume U.S. goods and services out of total compensation is 0.50, the Keynsian multiplier for the 1977-78 NJTC would be about 8.7, more than five times Mark Zandy’s (2008) estimate of 1.59 for the infrastructure multiplier.
    Despite its very significant implementation problems and distortions, the 1977-78 NJTC clearly had substantial effects on employment growth. Would a marginal employment subsidy implemented in 2009 and 2010 be as successful? Conditions are different. We are now heading into a recession trough, not climbing out of one. The problem is stag-deflation, not the stag-inflation of the 1970s and early 80s. Many credit markets are frozen. Skeptics ask “How will entrepreneurs finance additional employees, if credit is unavailable.” But external financing was also difficult in 1977 and 1978. The cost of equity capital—the earnings to share price ratio of the S&P500–was 10.8% in 1977 and 12.0% in 1978 compared to 7.8% at the end of November 2008. Interest rates on Baa rated corporate bonds were also higher in 1977 than in November 2008.
    The most important difference between then and now is that the lessons of the 1977-78 experience can improve the design and administration of a 2009-10 NJTC and the internet allows us to more rapidly inform employers of its features.
    For graphs of data and lessons go to http://digitalcommons.ilr.cornell.edu/articles/184/

  2. Anonymous  ::  4:39 pm on January 9th, 2009:

    With all due respect to Len Burman, I think it should be noted that there is considerable theoretical and empirical research support for the notion that SOME type of wage subsidy program might do something useful to encourage job creation during recessions. I don’t think that it is convincing to simply dismiss the notion by citing the opinion of one person, Emil Sunley.
    If we’re citing Brookings publications, it might be noted that the Brookings Institution saw fit to organize two major conference volumes on the topic of wage subsidies. There is the conference volume from 1978 edited by John Palmer, “Creating Jobs: Public Employment Programs and Wage Subsidies”. There is a 1982 volume edited by Robert Haveman and John Palmer, “Jobs for Disadvantaged Workers: The Economics of Employment Subsidies”. These volumes have extensive discussion of research on various designs of wage subsidies in different countries.
    Wage subsidies have been favored by a number of prominent economists. Robert Haveman has long been an advocate of reviving the New Jobs Tax Credit. . Nobel-prize winner Edmund Phelps wrote an entire book advocating wage subsidies, in his 1997 book “Rewarding Work”. Harvard Professor Dani Rodrik recently wrote favorably of tax-linked employment subsidies at his blog, at http://rodrik.typepad.com/dani_rodriks_weblog/2008/12/a-proposal-employment-linked-tax-incentives-1.html Professor Dan Hamermesh of the University of Texas wrote a piece at the New York Times “Freakonomics” blog favoring Obama’s revival of the New Jobs Tax Credit, at http://freakonomics.blogs.nytimes.com/2008/10/17/an-example-of-economics-at-work/ .
    In addition to John Bishop’s work on the New Jobs Tax Credit of 1977-78, an article by Jeffrey Perloff and Michael Wachter in the American Economic Review in 1979 provided some empirical evidence that the NJTC was effective in creating jobs.
    I reviewed the evidence on wage subsidies in chapter 8 , engagingly titled “Wage Subsidies”, of my 2001 book “Jobs for the Poor: Can Labor Demand Policies Help?” On the whole, there is some evidence that such wage subsidies can make a significant difference if properly designed. Targeted wage subsidies to the disadvantaged are more complicated to design properly than more general wage subsidies, because targeted wage subsidies have to somehow deal with stigma effects, in which employers don’t want to hire disadvantaged workers identified as such by the wage subsidy program. Chapter 1 of this book, which summarizes the entire book, can be downloaded here: http://www.russellsage.org/publications/books/0-87154-097-5/chapter1_pdf . Some estimates from my book that are relevant to the effectiveness of a revived New Jobs Tax Credit are in a memo I released in October of 2008, available here: http://www.upjohn.org/Bartik-NJTC-proposal.pdf .
    Wage or employment subsidies tend to have a limited political constituency. Conservatives tend to be suspicious of these subsidies because they involve extensive government interference with private sector decisions about employment. Liberals tend to be worried that business will take the subsidies without changing employment levels. However, on the whole, the evidence suggests that such subsidies, if well-designed, will induce some significant job creation. As with all tax breaks or subsidies, they will also provide windfall gains for actions that will be undertaken anyway. The question is whether we can design wage or employment subsidies sufficiently well that the benefits from additional employment creation justify the costs of the subsidies, including the costs of windfall gains. The devil is in the details.
    The Tax Policy Center could make a real contribution by thinking through how an employment subsidy might best be designed in today’s economy. How do we encourage employment creation, particularly for the hard-to-employ, while minimizing windfall gains for employers? How do we do so, and yet keep the subsidy design reasonably simple? These issues have already been extensively discussed, yet might well benefit from a fresh look.

  3. Anonymous  ::  7:46 pm on January 9th, 2009:

    Tim, Thanks for your thoughtful posts. I don't think anyone is disputing that wage subsidies could boost employment, and Emil thought that Carter's original proposal for an across-the-board subsidy would have done some good. The problem is what happens to these proposals in a political setting, and the challenges of designing and implementing an incremental subsidy. My guess is that the most effective way to boost employment is to boost demand, and that is certainly simpler than designing an incremental wage credit. Also, in this particular recession, the capital market failures seem more pressing than any labor market failures. If firms are starved for capital, labor productivity falls. So the other top priority is getting capital flowing again.

  4. Anonymous  ::  8:04 pm on January 9th, 2009:

    John, Thank you for your post. I'm skeptical about the effects of the NJTC for reasons you and Howard mention–problems of causality and the possibility that those who knew about the credit were systematically different and more likely to hire than those who didn't. Is there any experience with state credits? That wouldn't entirely solve problems of spurious correlation, since states that offered credits might be in a different economic situation from those that didn't, but the differences might be controlled for more easily than in cross-firm regressions.

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