Would a Jobs Credit Work? A Response to Pozen

(Bob Litan)

Main Street is impatient with the pace of the recovery. Yes, the stock market has rebounded smartly from its March lows; and yes, government statisticians tell us that total output of goods and services actually increased at an annual rate of 3.5% in the third quarter, most likely marking an official end to the Great Recession. But on Main Street, unemployment has now passed 10%, and many more Americans are discouraged from looking for work, or engaged in part-time jobs unable to upgrade into full-time work.

No wonder then that policy makers in both political parties are frantically searching for ways to reverse the monthly job losses and start putting more Americans back to work. One idea that has attracted a lot of attention is a temporary tax credit or a partial or total suspension of the payroll tax to encourage employers to begin hiring again.

Robert Pozen, a thoughtful and experienced financial expert, recently provided some useful analysis of this idea, and came up with a highly targeted job creation proposal designed to provide the largest bang for the policy bucks (to minimize the impact on the uncomfortably large federal deficit). The notion is to provide a 15% tax credit, up to $100,000 per employee, for employers making net additions to their payrolls, but require that half of the new workers come from the ranks of the previously unemployed.

However, this proposal would limit the credit only for already established employers – those in business prior to some cutoff date (Pozen suggests September 30th of this year). The rationale for excluding all new firms from eligibility is to prevent existing firms from breaking themselves up or forming new subsidiaries or affiliates simply in order to qualify for the credit.

What sounds like a minor detail – the eligibility cutoff – would actually be a big mistake--for it reflects a fundamental misreading of which firms are most likely to hire new workers and sustain the recovery after the stimulus measures wind down and are eventually withdrawn.

A new Kauffman Foundation study documents that over the past three decades, until this recession, new firms (those one to five years old) have been responsible for much or all of the net new jobs created in our economy. Remarkably, even in the teeth of the recession, through 2008, the number of new business starts, as measured by another Kauffman study, has actually increased modestly. What we don’t know is whether the constraints on business credit or other impediments will deter these new firms, as well as those recently created, from continuing the historical pattern by being the prime source of net job creation now and in the years ahead. What do know, though, is that excluding new firms from receiving any job tax credit will certainly break that historical pattern – hardly the outcome anyone wants.

Fortunately, there is much more straightforward way to prevent the kind of gaming that Pozen worries about: in calculating the employment benchmark for determining whether a firm has added to its payrolls, the tax authorities should include all subsidiaries and affiliates in which a firm has an equity interest above a certain threshold (such as 10% of  an entity’s equity).

Meanwhile, policy makers should continue to look for other ways to boost the formation and growth of new companies, which are not only likely to be source of new jobs but of the next wave of new products and services that will restore optimism about our economic future.

Some examples: Establish a “job creator’s” visa for immigrants who launch new companies and hire workers; fix bank capital requirements so that they are less likely to discourage business lending in economic downturns (by making the requirements less pro-cyclical); allow shareholders to determine whether their companies should adhere to all or a portion of the requirements of the Sarbanes Oxley Act that make it more expensive for high growth companies to go public and thus expand on their rather than to sell out; and encouraging the development of a truly free market in the licensing of technologies developed by our universities using federal research funds, which would accelerate the commercialization of innovations that will reshape our future. (The House Financial Services Committee recently voted to extend the exemption of small companies from Sarbanes-Oxley's section 404(b). The measure still needs to pass the full House and Senate and does not affect the requirement that these companies comply with section 404(a).)

Agree or disagree, as you may, with some of these specifics. But the source of America’s remarkable job growth, our new firms, is not in dispute. As we all seek to dig our way out of our current economic hole, we cannot leave our entrepreneurs out of the solution, because they are the solution.

--Bob Litan