Unintended Consequences of Job Creation Tax Credit

October 07, 2009

Greg Mankiw discusses the problems of defining the marginal employee when it comes to the proposed Tax Credit for Job Creation:

The problem is, how do you define a marginal job? You cannot simply say "new hires." In that case, company A fires Peter and hires Paul. Company B fires Paul and hires Peter. That kind of employment churn is, presumably, not what we are trying to encourage.

Usually, these proposals measure marginal jobs by comparing employment to some base year. Thus, a company gets a tax credit for employment that exceeds, say, 90 percent of employment in 2007. But then, the incentives goes mainly to companies in regions and industries that are expanding or shrinking only slightly. Those regions and industries that are deeply contracting do not have an incentive for marginal hires, because their employment levels are now well below the base levels. The playing field is tilted against those regions and industries that have been hit hardest--a result that seems to diminish both equality and efficiency.

Also, how do you handle newly formed companies? Government should not penalize start-ups by subsidizing only employment by their incumbent competitors. But if new companies get the hiring credit, then existing companies are incentivized to create new wholly-owned subsidiaries in order to qualify for the tax break (while contracting employment in the parent company). Similarly, they are incentivized to outsource work to start-ups that get the credit.

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