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Employment tax credits: the 'marginal' approach to full employment

By Gavin Putland - posted Monday, 23 March 2009

Every industry lobbyist will regard rising unemployment as an opportunity to demand handouts or subsidies or tax concessions which just happen to benefit his/her industry. Meanwhile every ideologue will point to unemployment as a vindication of his/her ideology, which just happens to be vindicated by almost everything else that has ever happened. I've been known to indulge in the latter behaviour myself; but here, just for once, I shall refrain.

The truth, which most of the ideologues and all of the lobbyists don't want you to hear, is that the solution to unemployment is employment! When this fact is kept firmly in mind, the translation into Federal policy is straightforward.

The carrot: give every employer an Employment Tax Credit proportional to the growth of its in-house workforce since a certain reference date. The proportionality constant would be in dollars per year per full-time-equivalent worker.


The stick: allow the tax "credit" to be negative, so that downsizing the workforce after the reference date incurs a tax penalty.

The anti-rorting provisions: The "reference date" must be before the policy is announced, so that employers can't get a tax advantage by sacking people before the reference date and re-hiring them after it. Employers that materialise after the reference date must be subject to separate rules; they cannot be treated as if they had a workforce of zero at the reference date, because that would invite old employers to find ways to disappear and reappear.

The concession to hard times: give employers an unconditional tax cut if you wish; but be sure to apply the above carrot and stick in addition thereto. The unconditional tax cut would then be affordable because the carrot and stick would expand the economy and hence the tax base - not so much for corporate income tax, against which the tax credit would be given, but certainly for personal and consumption taxes.

Note that the employment tax credit by itself is revenue-neutral: if employers keep the same workforce, they get no credit. The tax credit merely makes public revenue less sensitive to employment, reducing the government's revenue windfall if employment rises, and reducing its revenue loss if employment falls. But because the tax credit would encourage hiring and discourage firing, employment would be higher than it would otherwise be, so that revenue would also be higher (although the tax credit would reduce the difference). It is therefore perfectly inane to ask how we can "afford" an employment tax credit. The onus is on the critics to explain how we can afford not to have one.

Would the restoration of full employment in this way be inflationary? On the contrary, the tax credit would reduce the marginal cost of hiring additional labour, hence the marginal cost of the associated additional production, hence the market price of that production. This anti-inflationary effect means that the tax credit would reduce not only the actual rate of unemployment, but also the "natural" rate - that is, the minimum unemployment rate consistent with stable inflation.

Now what about new employers that go into business after the reference date?


In the short term, new employers can be subject to the old law, including any unconditional tax cut but excluding the employment tax credit. This of course would make it harder for new employers to compete with old ones. But that's acceptable in the short term because unless something is done to end the recession, there won't be any new employers anyway (except in the bankruptcy industry).

In the longer term, the rules for new employers need to be such that (a) expansion of the workforce is no less attractive for new employers than for old ones, and (b) each new employer makes a substantial tax contribution through some alternative tax base, uncorrelated with the size of its workforce, so that the adequacy of revenue is not threatened by old employers finding ways to transform themselves into new ones.

Politicians contemplating tax reform normally fear a backlash from taxpayers who will be worse off after the change than before. But that problem would be minimal as regards the rules for new employers, because there is no "before" except for the tiny minority of employers who go into business after the introduction of the employment tax credit but before the introduction of the rules for new employers.

Of course I have my ideas on what the "alternative tax base" for new employers should be. But I said I wasn't going to get ideological. So I simply point out that the ideology behind the rules for new employers cannot involve any injustice to those who freely choose to start new enterprises under those rules, knowing what the rules will be. Let their willingness to start new enterprises be the test.

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About the Author

Gavin R. Putland is the director of the Land Values Research Group at Prosper Australia.

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