Ideas in Development

A new Job Growth Tax Credit would provide a 30 percent tax credit of the first $14,700 of wages paid to each additional employee over and above 102 percent of the baseline employment. In other words, the state would only subsidize additional employment for a firm. This incentive would be offered statewide to all sizes of business only in years of high unemployment.

A New Direction

States, like NC , that are concerned about job creation during times of recession and soft recoveries can provide more labor-intensive subsidies directly if job creation is a prime imperative. Indeed, one of the paradoxes of the field of business incentives is that most development subsidies are capital-based, yet they are supposed to create jobs. Such subsidies can create jobs, but they are less efficient than labor-targeted ones. Capital subsidies only generate employment as a byproduct of increased production; that is, employment increases are coincidental. However, this does not mean that capital subsidies are inherently good: It just means labor-targeted subsidies offer more direct and potentially cost-effective ways of creating jobs.

More than a dozen such labor-based programs have been run nationally, statewide, or as particular demonstration projects (and there are scores of illustrations in Europe). There is a rich evaluation literature.

For example, the New Jobs Tax Credit (NJTC) was launched as an economic stimulus in 1977-1978 by the Carter Administration. Although the NJTC was never enthusiastically embraced by the Treasury Department and was not marketed well, research evaluations suggest that it was effective in creating jobs for low-skilled workers and at a rather low cost to the federal government.

The NJTC provided a tax credit equal to 50 percent of the first $6,000 ($12,000 in 2003 dollars) of wages per employee for increases in employment of more than 2 percent over the previous year. Robert Haveman points out that the program did not distinguish among workers by their skill or unemployment status. However, the subsidy and hence the incentive for private employers to hire low-wage workers was a higher percentage of total wages for less skilled workers. Studies of the employment effects of the NJTC indicate that up to 30 percent of the 1978-1979 employment growth in the studied industries was attributable to the NJTC it was a potent job creation device. This was about 700,000 net jobs, with a net cost of around $13,500 per job.

Another program, which lasted from 1978 to 1994 was the Targeted Jobs Tax Credit (TJTC). This was a more categorical subsidy, focused on promoting the hiring of targeted groups, such as disadvantaged youth, welfare recipients, disadvantaged Vietnam-era veterans, handicapped workers, and ex-convicts. Employers claimed the credit for around 300,000 to 500,000 workers each year. The program went through many revisions. In its final year, it had been scaled back to 40 percent of first year wages, up to wages of $6,000 annually (in 1998 dollars).

TJTC dealt with a varied group of workers. Some fared better and were more likely to be hired and retained than others. There is some evidence that disadvantaged youth and the handicapped were the most successful participants. The take-up rate by firms, on the other hand, was rather low: roughly 10 percent of eligible hires were typically claimed on firms' tax returns. The factors that caused this low level of program participation include: problems of marketing the program, helping smaller firms deal with the paperwork, frequent changes in its targeting, and a stigmatization effect that actually made some of the claimants less attractive than the average (non-subsidized) applicant with the same set of skills and work experience. The best estimate drawn from examining numerous studies is that the tax credit made the hire happen in about 30 percent of the cases. The actual cost was quite affordable, ranging from $2,460 to $15,375 per job.

Both NTJC and TJTC were entitlement tax credits. All firms who met the program's criteria were entitled to the wage subsidy. There have been also a number of efforts that were categorical discretionary wage subsidies, where public entities chose which job seekers were hired and which firms received the subsidies.

What Could Work in North Carolina

We suggest that the state operate a job creation subsidy that would replace the Lee Act's investment and job creation tax credits with a two track approach: (1) an entitlement tax credit initiative and (2) a discretionary grant program (e.g., Targeted Job Creation Grant). The tax credit would exist during recessionary years and the grant program for four years initially. Tax and grant claimants would be allowed only to use one of these tools at a time for a job. So, they must elect to use one window or the other. The Job Growth Tax Credit would work as follows.

The Job Growth Tax Credit

The Job Growth Tax Credit, is a refinement of the NJTC, one that is tailored to the state of North Carolina. During years in which the state's unemployment rate exceeds 5%, it would provide subsidies for employment only on the margin (and not finance all current employment). It would apply to for-profit firms that expand employment and be paid to the firms. In so doing, the tax credit lowers the cost of labor for employers, hopefully spurring a substitution of labor for capital. The structure of the credit safeguards against a firm firing all of its current employees and hiring twice as many half-time workers who qualify for the tax credit and minimizes the advantages of hiring additional part-time workers.

Under this proposal, the credit would be available for firms that increase their employment beyond some percentage (say, 2 percent) over the base year's employment level; the base year is that year in which the state's unemployment first exceeds 5%. The credit would exist until the state's unemployment rate falls below 4.5%. Based on typical business cycles, we expect the credit to exist for multiyear stretches (probably three or four years at a stretch). Assuming that the baseline year is announced after January 1st, the period in which the credit may be applied should be free of gaming behavior by firms; that is, firms will be unable to adjust their baseline employment to maximize their later tax credits. During that period, any firm that increases its employment more than the prescribed percentage will receive the credit. The multiyear period would help firms make investments that require more time, investments that support increased employment (e.g.expansion of a plant). The credit would be available for each year that the firm increases its employment above the targeted amount.

This design is superior to a rolling baseline or a multiyear employment average because it eliminates incentives for the firm that manipulates its employment simply to maximize its tax credits. That is, under a permanent, on-going tax credit, a firm can increase its employment in the first year after the baseline to get its credit; during that year, it can stockpile surplus output. In year 2, it can reduce employment but sell its stocks to maintain revenues from sales. In year 3, it can increase employment again (this time over the new baseline of year 2 employment) to capture the tax credit. This can go indefinitely.

The design is anti-recessionary, countercyclical. By encouraging expansions in employment during high unemployment periods, the state is rewarding firms that act, perhaps hastening the recovery. It is possible that firms may delay expansions until recessionary years (assuming that the credit is made permanent and known to kick in during times of high unemployment), but there are few firms that will postpone expansions for years in hopes of gaining a tax credit. (This would also be hard to pull off, since recessions and unemployment rates are not perfectly predictable.)

The credit would be applied only to an individual's wages up to some cap (such as 30 percent of the first $14,700 of wages ), which would tend to provide an above-average subsidy of jobs for lower-skill and lower-wage workers.

To mitigate windfalls to firms that would have increased their employment without the tax credit, firms must submit a letter of intent in the first six months of the year to be followed by a completed application for the credit prior to year's end. Some firms that receive the credit will be doing so simply because their expansion plans coincide with the tax credit. Other firms will have chosen to expand because the tax credit made it profitable for them to do so.

Under the tax credit, the credit to a firm will be equal to: 30% of the first $14,700 of wages paid to each additional employee over and above 102% of the baseline employment with no cap.

Desirable Program Features

Analogous employment programs have been successfully run both here and abroad. Research documents that wage subsidies for the jobless or less skilled workers are likely to be more effective when utilized in conjunction with labor market intermediaries that help provide some training, placement services, and job retention assistance.

What's appealing about this strategy is that it does not fit conveniently into any one of the boxes typically used to describe comparable programs. It is an economic development tool. It supports existing and new businesses. Small and large firms are eligible as well.). It is a temporary, countercyclical adjustment program for recessions.

This program would also help level the playing field for all communities. Many will never land a prime business attraction project, but all have indigenous firms that might expand with an injection of money. All can play and win in this game. Further, it focuses on aiding communities and workers when they really need help during a recession. (It is not costing the state anything when the NC economy is strong and the program is in its dormant state.) The Job Growth Tax Credit also does not require any initial out-of-pocket outlays by the state..

CFED projected that it would create many more jobs than the Lee Machinery and Equipment credits, because of it is subsidizing labor. Further, we would argue that its batting average would be higher: 30% of proposed Job Creation Tax Credit would likely be induced by the credit, rather than the UNC estimate that only 4% of the Lee Credit jobs were induced by the Lee Act. Our projections estimate that 26,806 jobs would be created statewide annually, as compared with the Lee Act's record of 3,400 jobs statewide. (See matrix for more background; or go to the CFED paper on There Are Alternatives to Traditional Business Incentives -- www.cfed.org ).

And what might account for this performance difference? It subsidizes labor rather than capital. Its use of a baseline gives it a stronger likelihood of fostering additional jobs than the Lee Act. It being triggered by a 5% unemployment rate also means that job creation numbers would be down and any increase in employment would likely have to be induced by some sort of policy stimulant. Lastly, its unpredictability (it is triggered by an unemployment rate) and its on-and-off features make it much more difficult for private firms to game.

⁶ See Katz and Molina publications in the bibliography. Also go to Job Initiative program of Anne E. Casey Foundation www.aecf.org . There is extensive list of relevant publications to consult for more research on the role of labor market intermediaries.
⁷ In short, the programs are synergistic. Their creators (Haveman, Bishop, Bartik, and others) sought to think outside the box when they were developed.