How to Create Jobs: Tax Credit v. Payroll Tax Holiday

Official unemployment will likely cross the 10 percent barrier in the next few months, but if you count part-time and discouraged workers, you get something closer to 16 percent of the work force, which is horrible from any perspective and downright terminal for incumbents in 2010. Two of the most interesting ideas for fixing unemployment involve a payroll tax holiday and a tax credit for companies who hire workers. Which idea is better?

In broad strokes, the difference is this: The tax credit would likely be smaller and more surgical, with the benefits going to companies to reduce the marginal cost of new hires. The payroll tax chops FICA taxes (your Social Security and Medicare contributions), which are shared by employers and employees. That means businesses would have more money to make hires and workers would have more money to spend. It also makes it a blunter instrument that lacks incentives as specific as "no money until you hire."

The Economic Policy Institute says a job creation tax credit could create 5.1 million jobs in two years, costing the government about $27 billion. Timothy Bartik and John Bishop write:

• A job creation tax credit that refunded 15% of new wage costs in 2010 and 10% of new wage costs in 2011 could create 5.1 million additional jobs in the U.S. economy over these two years.

• The net cost of the tax credit would be roughly $27 billion, or about $5,400 per new full-time-equivalent job created over these two years.

The problem with these "tax incentive" policices is that they can always be gamed. Employers might try to finagle tax credits for hires they've already made, or were poised to make anyway. Some are concerned that firms might fire workers before the start date of the credit and hire them back when the credit kicks in, which would effectively mean the government's just handing out money to the companies.

Now let's consider the payroll tax. Michael Kinsley wrote a great defense of the payroll tax holiday during the debate over the first stimulus. Here's his argument:

FICA [Social Security and Medicare taxes shared by employer and employee] is, in effect, a tax on job creation. It applies to the very first dollar earned by a minimum-wage worker, but most of it tops out at an annual income of about $100,000 and doesn't apply at all to income from investments. For most Americans holding jobs, FICA now takes a bigger chunk of their income than the income tax itself. And yet it rarely enjoys the tender concern of tax-cutting Republicans, who prefer to concentrate on tax breaks for capital gains. Cutting the FICA tax in half, for workers and for employers, would make it more affordable for employers to hire -- or avoid layoffs -- while giving everyone who makes less than $100,000 a 7.5% raise to spend and stimulate the economy even further. People making more than $100,000 would get a tax cut too -- as big as anyone else's, though a smaller percentage of their incomes.

In December 2001, in the teeth of a not-quite-Great Recession, some guy named Peter Orszag with the Center on Budget and Policy Priorities outlined the challenges of a payroll tax holiday: namely that it doesn't help low-income workers enough, and that it could produce a windfall for businesses without guaranteeing that the money will be spent on new hires.

So which is better? My first instinct was to go with the job creation tax cut because I admired that it was a targeted stimulus rather than a broad cut. But right now I'm leaning toward something like Robert Reich's payroll tax cut proposal on the first $20,000 of income. That would make the stimulus highly progressive and limited, but maintain the dual benefits of the payroll tax cut--giving both employers and employees to spend more money on hires and goods.