Wednesday, October 7, 2009

A tax credit for new hires

Today's NYT reports that a bipartisan consensus is building around a proposal to give employers a tax credit for new hires. The article reports that wages would be subsidized by 15% in the first year and 10% in the second year in a two year program. The basic economics is very straightforward, employers will hire more people than they would have in the absence of the subsidy and workers will end up with higher wages and salaries. In a severe recession, these might seem like deadweight loss triangles we could live with (at least at first glance), especially compared to the "cash for clunkers" program.

The most significant criticism of this policy is that it will pay many employers a bonus for something they would do anyway. To get a feel for the numbers, employment is about 140 million. For a new worker, this amounts to a 15% cut in the price of labor. Elasticity of demand for labor is about -0.5, so this is likely to result in a 7.5% increase in new hires. So if employers were to create one million new jobs in the next three months, the subsidy would create an additional 75,000 jobs. Of course the employers would collect the subsidy for all 1.075 million jobs, costing the Treasury roughly $8 billion (assuming an average labor cost of $50k), or a bit more than $100k per job.

For the same expenditure, the government could select 160,000 random unemployed persons and give them $50k each per year for two years. Of course we won't see that option discussed. As discouraging as this sounds, the taxpayer cost per job created/saved for the employer tax credit is actually very favorable, especially when compared to the Chinese tire tariff and cash for clunkers.

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