Parsing the President’s Jobs Plan

blitt chandan 18 Parsing the President’s Jobs Plan

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?

Arthur Okun addressed the general question in a 1962 article describing the empirical relationship between real economic output and the unemployment rate. Okun was among the leading economists of his day, leaving a professorship at Yale to become chairman of the Council of Economic Advisors and then a Senior Fellow at the Brookings Institution.

Okun’s rule of thumb is generally referred to as a law even though it describes a loose relationship between output and employment that has been elaborated and expanded in subsequent decades. In its original specification, the unemployment rate falls by 1 percent with every 3 percent increase in economic output. This implies that the unemployment rate will fall to 9 percent by year’s end and that the number of new jobs will fall far short of losses in 2008 and 2009. According to the Congressional Budget Office’s January projections, the unemployment rate will trend down to an average of 10.1 percent in 2010 and 9.5 percent in 2011.

The exact relationship between growth and employment is conditioned over a range of factors, including labor productivity and labor force participation. Edward Knotek, at the Federal Reserve Bank of Kansas City, points out that “[it] is a statistical relationship rather than a structural feature of the economy.”

That relationship may change over time. In recent decades, there is reason to believe that the relationship has weakened. Of particular concern, the Kansas Fed elaborates on the phenomenon of the jobless recovery: “[These] are periods following the end of recessions when output growth resumes but employment does not grow. It is possible that the advent of jobless recoveries is symptomatic of a fundamental change in the timing of the relationship between output and the labor market. …”

In reducing the tax burden for businesses in a way that is specifically linked to job growth, the administration is adopting a policy alternative that can have a positive impact on employment. If only our fiscal situation allowed for a permanent payroll tax reduction for middle-income workers. As I described in my early December column that followed the release of the November Employment Situation report, the economy has yet to demonstrate its capacity for private payroll growth. A return to robust positive absorption depends upon the labor market’s moving past stabilization and replacing the millions of jobs that have been lost in the contraction.

I went on to state that the public sector cannot create these jobs, nor should it; a more favorable climate for private-sector job creation can and should create them. Reducing the costs associated with payroll growth, by cutting or deferring payroll taxes for net new employees, may be the most economically efficient policy option available to Washington. By extension, it is exactly the type of policy that we should expect from an administration that is serious about encouraging jobs.

Sam Chandan, Ph.D., is president and chief economist of Real Estate Econometrics and an adjunct professor of real estate at Wharton.

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