Creating Jobs Programs: Worker subsidy vs employer hiring credits

David Neumark of University of California, Irvine writes this superb paper on the topic (a longer version here). Best part of the paper is it takes you to the simple micro-eco graphs once did in college.

First rising and now sticky US unemployment has been  the central point of the crisis. Now there have been many policies to boost employment levels. This paper looks at the direct policies to boost employment.

There are two direct ways to boost employment:

• Worker Subsidy: In this government pays the worker a subsidy in case he is employed. So, a worker gets wages+subsidy. This increases supply of the workers.
• Employer credit: In this, government gives employers credit on the workers employed. A worker gets wage + credit but an employer pays only wage. So the cost of labour goes down leading to rise in demand for labour.

WS program leads to higher supply of labour and EC program leads to more demand for labour.  See the nice graphs in the paper for more clarity.

Both have their +ves and -ves. In US worker subsidy is also called Earned Income Tax Credit (EITC).

A potential problem with the EITC is that it creates disincentives to work for some recipients. The EITC unambiguously encourages some people not working to enter the labor market. However, for many of those already working, the EITC creates work disincentives by raising recipients’ incomes and perhaps also lowering their effective wages, thereby making work less attractive. Thus, the EITC creates incentives for some people to reduce their working hours. In families with multiple earners, the EITC can create incentives to exit the labor market.

Hiring credits present two complications (Dickert-Conlin and Holtz-Eakin 2000). First, a hiring credit may pay employers for hiring they would have done anyway. Estimates of the share of credits paid for hiring that would have occurred without the credit—referred to as windfalls—can exceed 90% (Bartik 2001). But efforts to substantially reduce windfalls by rewarding net job creation can lead to large administrative costs that make hiring credits less attractive to employers.

Second, hiring credits that target disadvantaged workers may stigmatize them. Eligibility for the credit may transmit a negative signal to employers that offsets the effect of the credit. In contrast, the EITC avoids stigma because employers typically do not know who is eligible.

 The empirical evidence shows EITC works but hiring credit is not as effective.

A number of researchers have found hiring credits targeting the disadvantaged to be quite ineffective. One problem is low utilization by employers, probably because of administrative costs and stigmatization of targeted beneficiaries. Another problem is large windfalls (Bartik 2001; Katz 1998). In addition, hiring credits do little to increase incomes of low-income families for two reasons: many low-wage jobs are taken by workers whose families are not low income; and many low-income families have no employed members (Dickert-Conlin and Holtz-Eakin 2000).

But in this crisis as demand for labor is low, targeted hiring credits  is a better policy:

Thus, in normal economic circumstances, using the EITC to create jobs confers four advantages. First, the EITC does not create stigma effects. Second, it is easy and inexpensive to administer. Third, worker subsidies such as the EITC do more to help low-income families. Fourth, there is clear evidence that the EITC increases employment.

Nonetheless, in the aftermath of the Great Recession, hiring credits are a more appropriate job creation policy. First, macroeconomic considerations appear to favor hiring credits. Figure 1 shows that the worker subsidy increases employment because the market wage paid by employers falls. But it seems likely that part of the reason for currently high unemployment is insufficient labor demand coupled with a nominal wage above the market-clearing level. In this situation, a higher EITC would result in more people looking for work without lowering the wage or increasing employment.

Second, recent proposals for hiring credits have been noncategorical, that is, focused on the unemployed defined broadly. With unemployment above 8%, eligibility for such a hiring credit would probably carry little stigma. Clearly, in the current downturn, many people have become unemployed through no fault of their own. Given anemic job growth during much of the recovery, basing eligibility simply on whether a business’s employment is growing might couple acceptable windfall costs with low administrative costs for employers.

And how should the hiring credit program be designed?

What types of hiring credits are likely to be most effective at increasing overall employment? A hiring credit that is fully noncategorical, focused on the unemployed generally, would be more likely to avoid stigma. The 2010 HIRE Act, although not very generous, had such broad targeting. The recently proposed AJA in part targets the long-term unemployed. This raises the possibility of stigma effects. However, in the current environment, with over 40% of the unemployed reporting jobless spells of at least six months, restriction of the subsidy to this group may not stigmatize a worker.

An effective job creation hiring credit should create incentives for net new job creation. Neither the HIRE Act nor the AJA’s credit for the long-term unemployed has this feature. The AJA offers a payroll tax holiday provision for businesses that expand payrolls. This creates incentives for added jobs, if we assume that payroll expansions primarily occur as new hires rather than increased hours of work for existing employees. However, as currently structured, the AJA’s payroll tax holiday also applies to businesses that increase hours (or wages) without necessarily increasing head count. Labor supply on the employment margin is much more responsive to wages than labor supply on the hours margin. Therefore, a hiring credit focusing on employment would push out the labor demand curve along a flatter labor supply curve. That would generate a larger employment increase and a smaller wage increase. Thus, limiting the AJA’s payroll tax holiday to increases in employment would enhance the likelihood that it would create a substantial number of new jobs.

Superb paper on different lines. I mean one gets to read so much on US unemployment etc. but full of jazzy models. So you get papers which estimate how Fed’s policies led to lower unemployment via lower interest rates. Now, such papers are all based on many assumptions and model techniques.

This paper however looks at direct policies and takes you back to classroom with some really simple explanation..

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