Why Obama's Job Creation Plan Might Not Work

President Obama's $3.8 trillion budget for fiscal 2011 includes a jobs bill that could cost around $100 billion. In addition to small business credits and continued state aid, the White House has proposed a $30 billion job creation plan that would give employers $5000 dollars for each new hire. Last week I wrote that while the job creation tax credit has broad support among policy groups, including the CBO and the left-of-center EPI, it's also easy to game the system. Richard Posner finds a deeper flaw: It does nothing to juice demand.

Here's Posner:

The Keynesian theory of stimulus (the only theory that makes economic sense) is that if private demand for goods and services falls substantially below the economy's productive capacity (as it has done), government can replace the shortfall in demand by increasing its own demand. It can buy roads and airports and military equipment with borrowed money (so as not to take money out of people's pockets, in the form of taxes, and by doing so depressing private demand). And it can borrow cheap, because consumers are saving more than usual, and, with demand weak, businesses are borrowing less than usual. So the private demand for credit is weak, and interest rates therefore low. The surge in government demand increases production, and increased production results in increased employment.

The job-stimulus plan is not aimed at increasing demand, and therefore is unlikely to increase employment. For think: if a company is producing 1,000 widgets a year with a work force of 30, and it adds a 31st employee and thereby earns a $5,000 tax credit, the company's total costs will have risen by the wages and benefits that he pays the new employee minus the $5,000. But his sales will not have risen. Participating in the job-subsidy program will actually reduce his profits (revenue minus cost).

Last year I offered reasons for and against 9 big ideas to beat unemployment, from business tax credits to public works projects. One of those ideas is infrastructure spending -- that is, buying roads and bridges with borrowed money. The downside of infrastructure spending is that sometimes it takes a while to get the bridge-building projects off the ground. That's one reason why the CBO found that the jobs tax credit would actually be not only faster, but more effective at creating work hours.

At the same time, it's not clear even to the CBO that a hiring tax credit could work, or if it ever has. After the 1973-5 recession the New Jobs Tax Credit gave firms a tax break if they increased total employment by at least two percent. The policy was too complex for many firms to apply, and later studies struggled to agree that the tax credit boosted jobs by a significant number. A Department of Labor report ultimately concluded that it was impossible to observe what hiring would have been done without the credit.

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Derek Thompson is a senior editor at The Atlantic, where he writes about economics, labor markets, and the entertainment business.

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