Obama’s Job Creation Tax Credit: Cool Idea, Bad Policy

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A tax credit? For small businesses? To create jobs? And raise wages? Wow! What a great idea! What’s not to like?

Quite a bit, in fact. In his fiscal 2013 budget proposal, President Obama has suggested a temporary 10% tax credit designed to spur job creation and wage growth among small businesses. It’s a fine idea with a long pedigree — just the ticket if you’re in the market for small-bore economic policies that sound cool but don’t do much.

In recent years, there’s been a lot of talk, and even a little action, on the notion of job creating tax incentives. The Hiring Incentives to Restore Employment Act of 2010 featured a pair of credits, including one to encourage hiring unemployed workers. And Congress agreed last fall to create a new credit for the hiring of unemployed veterans.

This sort of legislation is obviously well intentioned. High and persistent unemployment is a blight on the economy. Left unchecked, it can even be a threat to democracy — research suggests that long-term joblessness is associated with support for authoritarian government.

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But here’s the problem: Job creation tax incentives don’t work. At least not well. And to the extent they provide the appearance of efficacy without the substance, they hinder the kind of economic policy that actually might put people back to work.

Obama’s Plan

Obama’s proposed hiring incentive would give employers a 10% tax credit for any increase in wages, whether from new hires or wage increases for existing employees. The credit would be calculated by comparing a company’s 2012 eligible wages, defined as Old Age, Survivors, and Disability Insurance wages, with its 2011 eligible wages. The credit is capped at $500,000 per employer, with an eye toward keeping it focused on small businesses.

In inspiration, if not in technical detail, the Obama credit harkens back to the new jobs tax credit (NJTC), enacted in 1977 and allowed to lapse in 1978. Like the Obama incentive, the NJTC was an incremental credit. Employers were eligible if they increased wages (calculated using aggregate unemployment insurance wages under FUTA) paid to at least 102% of the previous year’s wage base. The credit was 50% of the increase in the wage base, but various limitations reduced the maximum benefit per employee to between $600 and $1,800. A $100,000 overall cap effectively limited the number of new jobs the credit would subsidize to 47 per firm.

Over the course of its brief life, the NJTC cost the Treasury $5.7 billion but probably created only a handful of jobs. As Emil Sunley, former Treasury deputy secretary for tax analysis, later summed up: “The impact of the credit on jobs was slight.”

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Less slight, however, was the credit’s complexity. “No student of public finance, if left alone, would design a tax incentive as complicated as the jobs credit,” Sunley wrote in his essay tracing the NJTC’s legislative odyssey. President Carter had originally proposed a much simpler idea: an optional income tax credit of 4% of Social Security taxes paid by the employer. But Congress had other ideas. “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,” Sunley wrote.

The road to complexity is paved with good intentions.

Many subsequent analyses of the NJTC have echoed Sunley’s assessment. “The evidence cited by proponents that many jobs were created by the Carter-era program is not strong,” wrote Michael Ettlinger of the Center for American Progress. “It amounts to some correlations that are not very persuasive as to cause and effect, especially as it relates to the magnitude of any increases in employment.”

A Weak Case

Ultimately, the case for hiring tax incentives usually reduces to “something is better than nothing” or similar bromides. Supporters advance them as second-best solutions when more effective means of fostering job creation are politically untenable.

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That’s certainly the case today. Does anyone doubt that Obama and most congressional Democrats would much prefer to create jobs by stimulating aggregate demand through a large spending bill? Or even a general tax cut? Those options are deemed too expensive (especially in conjunction with the recent extension of the payroll tax cut), so symbolic stimulus like the jobs credit is all that’s left.

And that would be fine if it didn’t encourage lawmakers to keep trotting out similar proposals to advance whatever sort of policy aim they can’t achieve directly. After all, if you can’t make the case for direct spending to create jobs, how likely is it that you’ll be able to make the case for spending on, say, green energy innovation?

Almost always, tax incentives are a backhanded means of pursuing policy goals. In isolation they’re irritating, but often irrelevant. They don’t usually cost much, but taken as a group, they’re a blight on the tax system. And that can get very expensive indeed.

Joseph J. Thorndike is director of the Tax History Project at Tax Analysts and a Visiting Scholar in History at the University of Virginia. His new book, Their Fair Share: Why Americans Tax the Rich, will be published next year. He blogs at tax.com.