Government Should Use Tax Policy to Fight Unemployment

by: Investment Pancake

By official estimates, over sixteen percent of the entire country is either unemployed or underemployed, and in some cases not even looking for work. Over sixteen percent of our creativity, productivity, ambition, hope... rotting on the vine.

This is an emergency of almost unimaginable proportions. It is time for the government to act - not only with the blunt instruments of fiscal and monetary stimulus, but with a laser-like focus targeting unemployment specifically. This can be done through a simple, temporary tax policy change. Not only will this tax policy cost the American taxpayer nothing, it will generate tax net tax revenues instantly.

The solution is a refundable tax credit for every dollar of salary paid to a newly hired employee. It works like this. Currently, employers can deduct salary expenses from their income - assuming they have any income. This tax deduction shields some, but not all, income for the employer, so on an after-tax basis, hiring people costs employers money. For instance, if a Company earns $100 of gross income, pays Alex a $50 salary, and pays tax at a marginal rate of 50%, it costs Company $25 to hire Alex (without Alex, Company would have an after tax net profit of $50, but with Alex on board, Company only earns an after tax net profit of $25).

A tax credit works differently from a tax deduction, in that it can shield a greater portion (or, indeed, all) of the economic cost of a particular expenditure. Suppose Company got a $50 tax credit from the government for hiring Alex, instead of a tax deduction. Company would have $100 reported income, owe $50 in tax on that income, and the remaining $50 would go out to Alex as salary. But, Company would get a $50 tax credit for Alex's salary, wiping out its tax liability. At the end of the hunt, Company has a net after tax profit of $50 - just like Alex wasn't even in the picture.

It's immediately clear why companies would want to start hiring people if they could get a dollar-for-dollar tax credit for doing so. They'd basically get the work of these new employees at no net salary. The new employees win in the end, too - they have paying jobs now that they otherwise might not. And how does the government prosper? Simple. The new employees pay income taxes that the government would not otherwise collect. At first blush, it looks like everyone comes out ahead.

But, you might ask, doesn't that tax credit end up costing the government money it would have otherwise gotten if salaries for new employees were deductible, rather than credited? In our example, with a tax deduction scheme, the government gets $25 from Company, and with the tax credit scheme, the government gets $0 from the Company. That math is correct, but the argument assumes Company would have hired Alex in the first place. That assumption could (and generally does) work in a normal economy, but goes onto very shaky ground when the official unemployment rate goes into the double digits.

The truth is, companies are not hiring, and the government is losing income tax revenues as a result. What that means is that the tax credit for salaries paid to new employees won't cost much at all because it's money the government wouldn't have gotten anyway. A tax credit that neutralizes all or some of the economic disincentive for a company to go out and hire will instantly cause new employment to pick up. And because every dollar of the tax credit reflects someone's salary, that money can cycle straight back to the government in the form of personal income tax payments from all those newly hired people. So on closer inspection, it really does look like a win for employers, a win for employees and a win for the government after all.

To be sure, the devil is in the details. What if companies just fire everyone, and hire them right back the next day, just to get this tax credit? Answer: restrict the credit to only those who have never gotten a W-2 from the same (or any affiliated) company at any time in the last five years. What if the companies fire everybody and hire new people, just to get the tax credit? Answer: only offer the credit for salaries paid to new employees hired by companies for net new hires after turnover. What about investment bankers, who earn millions of dollars just for destroying the economy? Answer: cap the credit at $80,000, and phase it out entirely for salaries over $150,000. At this point, I'm just making these numbers up. What happens when unemployment drops to 5%? Answer: phase out the tax credit - have it expire after two or three years. Hopefully the economy will be somewhat more self sufficient by then.

Oh there are details to iron out, sure, but the point of this article is to introduce a framework for debate that really needs to start, and start quickly.

I have only one request from my readers. If you like this idea, I ask you to spread it around. Forward it to your Congress person. Put it in your own words, tweak it, and take credit for it. Be an economic activist, and get the idea out there - and get your friends to do the same. There are millions of people without jobs, without an income, without hope, who will thank you for it.