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Getting the biggest bang for job-creation bucks

By Alan S. Blinder
Friday, February 19, 2010; A17

Official Washington seems interested in only three things: jobs, jobs, jobs. But what are the real policy options? Broadly speaking, job-creating policies come in two varieties: general stimulus to boost growth and programs targeted specifically at job creation.

The first category follows the "build it and they will come" strategy: If you raise GDP, you will get more jobs. That's true. And it's the basic idea behind the Recovery and Reinvestment Act and countless other monetary and fiscal stimulus programs pursued by scores of nations since the Keynesian revolution.

But there's a catch: That strategy is expensive -- which matters when you have a mammoth budget deficit.

U.S. gross domestic product is about $14.5 trillion, and payroll employment is about 130 million jobs. Divide the two, and GDP per payroll job is about $112,000. It's great that we have such a highly productive economy. But it means that it takes about $112,000 worth of new GDP to create one typical job. Divide that $112,000 by a multiplier of 1.2 -- close to estimates of the job-creating impact of the Recovery Act -- and it takes about $93,000 worth of garden-variety fiscal stimulus to create an average job.

The search for a cheaper way leads to policies specifically targeted at job creation. The two main options are direct public-service employment and a new-jobs tax credit. The Obama administration and several members of Congress have proposed the latter. If most of the new public-service positions are low-wage jobs, and if the tax credit is designed well, the per-job costs of these policies are comparable: $30,000 to $40,000. I would recommend doing both, targeting roughly a million new jobs with each program, at a budgetary cost of perhaps $70 billion. While 2 million more jobs won't end America's gaping shortage, it would make a significant dent.

Public hiring is straightforward. But since federal civilian employment is limited, most such jobs would have to be at the state and local levels. So the federal government would be inducing lower levels of government to hire -- not unlike the idea behind the new-jobs tax credit.

There are two key design elements in any tax credit: minimizing the amount of the tax cut that is wasted (in this case, loses revenue without creating jobs) and minimizing possibilities for gaming the system. Notice that in both cases the gerund is "minimizing," not "eliminating." Perfection is beyond our capabilities.

Start with minimizing waste; that is, with maximizing the jobs bang for the deficit buck. We know three things for sure. First, many firms will ignore the tax incentive. That's fine. Such cases give us no "bang," but neither are any "bucks" expended. Second, many new jobs that receive the tax credit would have been created anyway. In such cases, there is again no real "bang," but deficit "bucks" go up. Third, by increasing the demand for labor, the tax credit will drive up wages (which is good), which will in turn kill some other jobs (which is not good).

Standard economic research can be used to estimate each of these three effects. The conclusion, in very round numbers, is that a $5,000-per-job tax credit similar to the administration's proposal should cost around $30,000 to $40,000 for each job created. That's vastly more than the $5,000 per job that a perfect policy would achieve, so the problems mentioned above are by no means trivial. Spending $35,000 per job instead of $5,000 sounds like a lot of waste -- until you remember that garden-variety fiscal stimulus costs closer to $100,000 per job.

Such estimates assume that most firms will not increase employment at all. People are often confused on this point, interpreting anecdotal or survey evidence that most firms will not respond as evidence against the program's efficacy. It is not. The tax credit will work as advertised if only about one firm in 10 increases its employment.

Unfortunately, we know far less about the second problem: Gaming the system. Apart from outright fraud, there are three major ways (and many minor ones) for firms to exaggerate the number of new jobs they've created in order to receive the tax credit.

One is to both fire and hire. That problem is easily fixed by awarding the tax credit only for net increases in head count above some base, such as last year's employment. A second gimmick is to replace full-time workers with part-time workers. That loophole can be plugged by offering the tax credit only to firms whose total payroll costs, not just head count, rise. Both of those points should be stipulated, as the administration's proposal does. But doing so renders the tax credit irrelevant to many firms that slashed employment during the recession and cannot return to their 2009 payroll levels quickly.

New firms pose a problem because they had no employees last year. Excluding them would render many of the economy's new jobs ineligible for the tax credit. But if we allow new firms to claim the credit, clever executives will create new firms in droves -- at least on paper. Congress was aware of this concern when we last instituted a new-jobs tax credit, in 1977. It decided then to "split the baby" by giving new firms half the tax credit.

All these possibilities for gaming tell us two things. First, the legislation must be drafted with care. Second, the agency that administers the new-jobs tax credit must be assiduous about enforcement. But given the jobs emergency and the impending budget calamity, that doesn't seem too much to ask.

The writer is a professor of economics at Princeton University and vice chairman of Promontory Interfinancial Network. He was formerly vice chairman of the Federal Reserve Board.

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