January 31, 2010
The Job-Subsidy Plan
The Job-Subsidy Plan—Posner
The President is asking Congress to enact a one-year $33 billion job-subsidy plan. An employer would receive a $5,000 tax credit in 2010 credit for increasing his labor force by one person and an additional subsidy for giving an employee a wage increase greater than the inflation rate. The total subsidy would be limited to $500,000 per employer, in the hope that the principal recipients would be small businesses. I do not know why the ceiling should be expected to have that effect. Even big businesses like $500,000 windfalls. If a big business happens to be increasing its hiring or its wages, why wouldn't it claim the subsidy?
That point to one side, and disregarding also the abundant possibilities of gaming the program, stressed by Becker, the proposal is unlikely to be effective because it violates the economic principles that ought to guide stimulus programs.
The theory of stimulus is Keynes's, is (in my opinion) sound, and is as follows. If, because a high rate of unemployment creates pessimism about the economic situation, people increase their savings at the same time that business is reducing its investing—and that is our situation today—the government can by financing projects through borrowing put the inert savings to work (inert because businesses aren't borrowing people's savings). The projects require workers, so unemployment falls, and with it pessimism and the cash hoarding, by consumers and businesses alike, that pessimism induces.
With Keynes's theory understood, it becomes possible to list the principles of effective stimulus:
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The stimulus must be large in order to make a substantial dent in unemployment. The $787 billion stimulus enacted last February may have been too small; a $33 billion jobs subsidy is a drop in the bucket.
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The stimulus must be implemented before recovery from a depression or recession is well under way—otherwise the government's borrowing to finance the stimulus will slow the recovery by pushing up interest rates. (That is, at some point in the recovery, business will resume investing and so will be competing with the government for capital.) If enactment of the job subsidy is delayed in Congress, or if procedures for preventing the gaming of the program are cumbersome, the subsidy expenditures may come too late to do any good.
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The stimulus must be targeted on industries, and areas of the country, in which unemployment is high. Like the $787 billion stimulus, the job-subsidy plan flunks this test as well.
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Most important, a stimulus is designed to stimulate demand, not supply. The economic problem for which a stimulus program is a solution is insufficient demand relative to the economy's labor and other resources. Because of overindebtedness and continued weaknesses in the financial system, consumers and businesses are reluctant to spend. Businesses are reluctant to hire (that is one aspect of their reluctance to spend), so unemployment is high and wages are stagnant, which further depresses demand. The idea behind the stimulus is for government demand to take the place of the missing private demand. Government "buys" new roads, in lieu of consumers' buying SUVs, and contractors meet the government's demand by hiring unemployed construction workers. The job-subsidy plan is not demand-focused, and so is unlikely to contribute to the economic recovery. Suppose a firm in a depressed economy sells 100 earth-moving machines a year, and employs 200 workers. If the government tells the firm it can save $5,000 on its taxes by increasing its work force to 201, the firm's total costs will increase (by the wages and benefits of the additional worker less $5,000), but its revenues will not increase because adding a worker does not increase the demand for its product.
There is an enormous amount of idle productive capacity in the U.S. economy at present. There is thus a case, as liberal economists such as Paul Krugman keep urging, for further stimulus spending. The problem is that such spending is irresponsible unless coupled with a credible commitment to repay, after the economy recovers, the money borrowed to finance the spending. Not only is there no such commitment; at present the only realistic prospect is of staggering deficits stretching indefinitely into the future. As a result there is at present no stomach for additional stimulus spending. The government is reduced to impotent gestures, of which the job-subsidy plan is one.
Subsidies to Small Business? Becker
President Obama, in his State of the Union Address last week, indicated that he would assist small business, particularly to encourage their hiring of additional workers. Two days later he proposed a $33 billion tax credit to small businesses that increase their hiring. I consider small and medium size business the backbone of any dynamic economy, so I sympathize with the President's desire to encourage these businesses. However, his proposal is not a good way to do this.
Obama's aims are laudable: to simultaneously increase employment, reduce unemployment, and encourage the expansion of small and medium sized businesses. Yet, as an employment-increasing plan, the President's approach has many problems, and is likely to have only limited impact. This is partly because while $33 billion is a lot of money, it is less than ¼ of one percent of American GDP. Yet even a much larger sum would have a small impact on employment. One reason is that the subsidy proposal gives small business some incentive to fire some employees, and then later to replace them with unemployed workers for whom they can collect the subsidy.
The unemployed hired under the subsidy program would likely receive higher pay than they would get otherwise because companies compete for these workers to qualify for the subsidy. Some workers might then remain unemployed rather than accept jobs in order to get the higher pay after the program is implemented. Employed workers at small (and even large) businesses might quite their jobs and become unemployed in order to become subsequently employed at other small companies in order to become eligible for any higher wages received by new hires. The President is aware that efforts will be made to game the proposal, and he proposed various safeguards. However, new ways will be discovered to get around the restrictions that would reduce the net job creating potential. Further efforts to close loopholes would lead the government to become more and more involved in the employment decisions of companies.
Smaller businesses are an important source of innovation and progress. Businesses like Microsoft, Wal-Mart, Apple, Google, and many others introduced game-changing innovations when they were very small that enabled them to grow very large, and they raised overall productivity. This is why it is so important to promote startups and other smaller businesses in an efficient and effective way. An effective approach has several components, and overall the US looks quite good compared to other countries. According to World Bank estimates, the US ranks 8th out of the more than 180 countries they consider on their overall index of the ease of starting a business, whereas, for example, Italy ranks 78th, and China 89th. On the other hand, the US ranks only 25th on the ease of getting construction permits, and 61st on taxes.
The US is tied for first place on the ease of employing workers. It is much easier for American small and medium size business to reduce their employment during bad times than it is for similar-sized companies in Europe, Latin America, or India. This helps explain why employment fell, and unemployment rose, more sharply during this recent recession in the US than in say Germany, Italy, and many other countries that have much less flexible labor markets, even when other countries experienced larger recession-induced falls in GDP.
Unfortunately, several proposals in Congress, and others mentioned by the President, would make it less attractive to start a business, or expand a smaller business. Although it is especially unclear after the election of a Republican senator from Massachusetts what any final health care bill will contain, some of the proposals would require all companies, with few exceptions, to provide health insurance for their employees. The fact that many small businesses do not now give their employees health insurance indicates that such a requirement would raise their costs, and reduce their employment.
Small and medium sized business owners are sensitive to capital gains taxes, increased taxes on larger incomes, and high rates of taxation on estates. Yet leading members of Congress have advocated increases in capital gains taxes, adding an additional tax on "high" incomes, and a return to higher estate taxes. These proposals would hurt all higher income persons, but might be particularly discouraging to startups,and to the expansion of smaller businesses.
I believe that smaller businesses can competes effectively against more sluggish larger and more established businesses without getting special privileges, such as the President's additional proposal to subsidize bank loans to small businesses. However, small business does thrive much better in an environment where success is not taxed at high rates, and where regulations and mandates do not have a disproportionately large effect on their costs and profits.