A proposal: employment-linked tax incentives

One important unknown about the fiscal stimulus plan is how much bang for the buck it will provide.  Call it the Keynesian multiplier or whatever else you want, the issue is the magnitude of employment and real GDP a given fiscal spending can generate.  Much of the discussion about the stimulus plan focuses on the amount of stimulus needed, the composition of the spending boost, and the extent to which you need tax reductions to complement the spending boost.

My main worry about the efficacy of the fiscal stimulus--aside from the international spillovers in case it is not supported by equally ambitious fiscal plans elsewhere--is this: households that face considerable employment uncertainty, and hence about their to future income prospects, are unlikely to go on a big spending spree. Just as banks are hoarding cash, households will try to preserve wealth by increasing saving at the margin.  This reduces the marginal propensity to consume, and renders the fiscal boost rather ineffective.

Why not try to deal with the looming unemployment problem, and the huge sense of risk and uncertainty it creates, more directly?  What I have in mind is subsidizing employment directly by providing employers incentives to keep people on the job.  We could imagine for example a scheme whereby firms received tax incentives on a sliding scale in relation to the size of their payroll. If you reduce your payroll, you get nothing. If you keep it unchanged, you get tax benefits. If you increase it, you get even more tax benefits. 

This would allow firms to dismiss employees who are not performing and would not interfere greatly with the normal churning of the workforce. Firms could still lay off workers, but they would now have an incentive to hire enough new workers to make up for the reduction in their payroll.

The idea is to target employment more directly and to deal head-on with the most severe consequence of a recession: job loss or the fear thereof.  We have had a lot of thought on how to increase confidence in the financial system.  We also need to think some of about the loss of confidence on the part of ordinary workers. 

So call this a worker confidence enhancement plan.

Comments

[indregard]

What do you mean by "size of their payroll"? Absolute size? As a percentage of total costs? Relative to their pre-incentive-scheme payroll?

Besides, won't this scheme make it harder for small firms to compete with MegaCorp?

To me, it seems like a better idea to increase the duration and amount of unemployment benefits and public spending on training, and give tax benefits for companies who pay for retraining employees-

[Dave Levy]

I would add other ideas to the table:

1) 401K Matching Tax Incentives (sliding scale for every dollar matched)

2) Health care Matching Tax Incentives, etc

http://www.spreadsoncredit.com

[gre_wireless]

I always thought that the general consensus was that labor markets in the US are quite flexible

[barry]

Why do you claim that this scheme would not interfere with the nornal churning of the workforce? It would clearly interfere with the structure of production, in as much as it caused some firms (such as the Detroit automakers) to remain in business when market forces would otherwise shut them down. What is the advantage of this plan--forced wealth redistribution to a special class of workers--if it continues the production of goods that consumers do not want? What benefit is there of socializing the costs to entrepreneurs for bad choices in the allocation of capital? How is this efficacious?

[Erika]

Obama actually has an employment tax credit similar to the one you describe in his stimulus plan.

There are a number of practical problems with imposing such employment tax credits, particularly the definition of 'employment growth' (over what time? At what level of the firm?) and how the tax agency would determine growth (the only administrative data source available to them is FUTA taxes, which are not well suited to measuring employment growth) and how to design such a credit so that you don't encourage firms to do things like bulk up on part-time employment to obtain the credit.

[GuruAtMoneyAssistant.org]

Dani:
Interesting comment. Yes, employment is a major issue, but equally important is income levels. Given the real unemployment levels, taking into account earning significantly less than in prior years due to pay based on sales levels, productivity, profits, or commissions, keeping people on the payroll is not the answer.

Having workers working and being productive, thus stabilizing the compensation levels of the employed is crucial.

An example would be the real estate agent, who may have earned $100,000 in years past and is now earning $25,000. They are employed, but their earnings are down and their spending is down.

The local cop who made an extra 30% compensation working overtime, is now earning only their base because overtime has been eliminated. Thus, his/her consumption is off, though they are employed.

Until the fear of declining incomes (not necessarily unemployement) is relieved, our consumer driven economy will continue to slip and slide further into the economic abyss.

[Steve Roth]

Why not just ramp up the Earned Income Tax Credit instead of creating a new program? It achieves the same effect as subsidizing employers' payrolls (it is, effectively, subsidizing employers' payrolls), without the intermediation.

The EITC is the most effective and efficient redistribution (i.e. demand-sustaining) vehicle we have.

But it's anemic; for single people, it's almost nonexistent.

For good discussion of the EITC see Chapter 8 of Lane Kenworthy's Egalitarian Capitalism.

Ceteris paribus, if the EITC had been far more generous in the last decade or two, and if we'd taxed sufficiently (and progressively enough) to pay for it, I would suggest that consumer (hence aggregate) demand would have been at a sufficient level to maintain a virtuous equilibrium, without the necessity for excessive consumer leveraging that was a huge factor in getting us to this point.

[Chandan]

But still, isn't your proposal is an indirect Keynesian fiscal stimulus?

[JTapp]

Why not eliminate the payroll tax?

[Sam Z.]

Dani

Isn't this roughly what the German stimulus is trying to do?

http://www.ft.com/cms/s/0/78cda1a4-cad8-11dd-87d7-000077b07658.html

"Under the plan, large companies would renounce mass redundancies for a period yet to be defined, in return for a rise in government subsidies for employees placed by companies temporarily on shorter working time or lower wages."

Sam.

[MikeF]

Interesting plan. It sidesteps the inefficiency and politicization of infrastructure spending rather neatly.

[John Bishop]

Much more attention needs to be given to Obama's proposed New Jobs Tax Credit. If well designed the marginal cost of labor and output and barriers to entry into new markets will fall substantially for two years. The purpose would be to induce some of the nations six million small employers to undertake a risky and aggressive expansion at a time when skilled workers are available and their competitors are weakened by commitments to flawed business models. If passed quickly, it could start creating jobs by the end of the first quarter of 2009. Might that start restore the animal spirits of small business?

The linked paper reprises research published in AER and elsewhere on the impact of the 1977-78 NJTC. The data suggests that it temporarily increased employment at very low cost in terms of tax revenue foregone. During 1977 and 1978 growing firms got a tax credit of up to $2100 for each extra worker employed. Despite a late start and poor marketing, the credit added at least a million jobs by December 1978 for a first round bang for buck of roughly 4.35 to 1. (Bishop 1981, Perloff and Wachter 1979). Private employment rose more rapidly from December 1976 to December 1978 than any other two year period since 1952. The NJTC's rules favored small firms. As predicted industries dominated by small firms grew more rapidly than industries dominated by large firms or by non-profit organizations ineligible for the credit. It encouraged hiring of part time workers and indeed employment grew more rapidly than total hours.
For more on the NJTC see http://digitalcommons.ilr.cornell.edu/articles/184/

[mk]

I agree with some other commenters: Why not increase the EITC, cut payroll taxes, and/or cut income taxes?

Sounds like you're trying to specifically incentivize businesses to keep a maximum number of people on their payroll, but given that tax incidence is a function of elasticity rather than "who the law says is taxed," does it really matter whether we target employers or employees?

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[Youri_Kemp]

Hi all,

The more and more I think about the credit crisis and the lack of confidence that fuels it, the more and more I feel that it is the lack of innovative productivity, which has everyone at a stand-still.

We need a best new thing. We need new things, period. Everying is played out and our senses, are filled with the same old same old; car; toys; jewlery; stocks and bonds and; everything else we can get our hands on.

As a world people, we are emotionally spent.

Folks are just tired!

We are in a funk of stagnation of ideas and creativity, in addition to the concentration of high wage earning jobs, to the few.

The idea which I would like to see come out of this as a reality, is the stronger promotion of a middle and lower stock market---microfiance on steriods. But, if we were to put it on capitalistic steroids, it would not be the small and medium market anymore.

Alas....we are screwed, unless people get to enjoying spending money, they made, again, without fear of loss of jobs.

We need secure jobs now, progressive entry into higher wage earning jobs for the progressively working and the securitization of that fortune as well. And, new technologies, with the capacity to excite the crowd about living again.

Best,

Youri
http://globalviewtoday.blogspot.com/

[Punditus Maximus]

I like this idea, but anyone who lives in a city will tell you that there is a plenty large backlog of basic maintenance which could be funded immediately and would require very little in the way of political discussion to direct.

[Jan Tomas Owe]

How about redistributing income and wealth to reignite the economy?

The less fortunate spend more of an additional dollar than the well to do. Redistribution can boost demand without increasing public deficits. Redistribution is more easily designed and implemented than rescue plans for loud businesses. It preserves consumer sovereignity. And it counters deflationary pressures.

Growing inequality is a major explanation for the crises. For many of the weaker households credit growth has been a substitute for income growth. In addition to tax breaks for the weaker households, we need increased unemployment benefits to bolster demand from both unemployed and employees in fear of loosing their jobs. This will also improve the bargaining power of the weakest employees and contribute to reduced wage differentials in the slightly longer run.

But it is essential that the informal economy is kept in check. With higher minimum wages more and more employers will want to hire illegal labourers. And even legal workers will be willing to accept sub standard terms if they can simultaneously collect generous benefits. ID-cards for all wage earners will be needed to keep the tax base intact.

Jan Tomas Owe
Economist
Norway

[Leslie]

I would also want to make sure that firms don't en masse fire older workers and replace them with lots of cheap entry-level workers just to get the tax credits. Maybe provide an across-the-board payroll credit for all workers employed? Or a small tax on laying people off or cutting their hours or salaries that's used to fund worker training programs?

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