BACKGROUND PAPER 

Employment Subsidies 

and Employment Tax Credits 

April 1977 

Congress of the United States 

Congressional Budget Office 

Washington, D.C. 

EMPLOYMENT SUBSIDIES 

AND EMPLOYMENT TAX CREDITS 

The Congress of the United States 

Congressional Budget Office 

For sale by the Superintendent of Documents, U.S. Goverwnent Printing Office 

Wasbtngton, D.C. ilO402 - Price $2.20 

PREFACE 

Both the Administration's Fiscal Stimulus Package 

for fiscal years 1977-1978 and the Tax Reduction and 

Simplification Act of 1977 (H.R. 3477) include a proposal 

for an employment tax credit, as do a number of other 

bills pending in the 95th Congress. Congressional 

interest in a wide variety of employment subsidies persists. There has been virtually no experience with them 

in the United States, however, either as a direct subsidy 

program or as a tax credit. 

This paper is based on memoranda and draft analyses 

submitted to Senate Budget Committee staff in January and 

February 1977 in response to a request from Senator 

Edmund S. Muskie. In accordance with the Congressional 

Budget Office's mandate to provide nonpartisan analysis 

of issues before the Congress, Employment Subsidies and 

Employment Tax Credits contains no recommendations. 

The paper was prepared by Ronald Hoffman and Mickey 

Levy of CBO's Tax Analysis Division, Mary Kay Plantes of 

the Fiscal Analysis Division, and David Mundel and 

Marc Freiman of the Human Resources and Community Development Division. Charles Davenport of the Tax Analysis 

Division made specific contributions and provided general 

supervision. George Iden of the Fiscal Analysis Division 

made a number of helpful comments. Special thanks go to 

Marvin Phaup of the Fiscal Analysis Division, the internal 

reader, whose valuable criticism was accompanied by 

specific suggestions for improvement. The manuscript was 

edited by Patricia H. Johnston, and AIda Seubert typed it 

for publication. 

April 1977 

Alice M. Rivlin 

Director 

iii 

TABLE OF CONTENTS 

Page 

Preface. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . iii 

Summary. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ix 

Chapter 1 Introduction.... ........... .............. 1 

Chapter II Alternative Employment Subsidies. .... ... 3 

General Employment Subsidies..... ...... ...... ... 3 

Effects on Employment. ........................ 3 

Effects on Inflation.......................... 5 

Effects on Structural Employment Factors...... 6 

Marginal Subsidies--Subsidizing Increases 

in Employment................................... 7 

The Base and Job Creation. ...... ........... ... 8 

Anomalies of Larger Subsidies for 

Increased Employment.......................... 8 

Variable-Base Marginal Subsidies.............. 9 

Categorical Employment Subsidies................ 11 

Alleviating Structural Employment Problems.... 11 

Reducing Aggregate Unemployment............... 13 

Lessening Inflationary Tendenc ............. 13 

Chapter III Program Design and Administration..... . 15 

Administrative Complexity, Job-Creating 

Effectiveness, and Program Costs. . . . . . . . . . . . . . . . 15 

General Employment Subsidy.................... 15 

Employment Subsidies with Limited 

Eligibility................................... 16 

Marginal Subsidies............................ 17 

Variable-Base Marginal Subsidies.............. 19 

Selective Ceilings That Limit the 

Amount of the Subsidy......................... 20 

Categorical Subsidies.... ... .... .............. 22 

Other Provisions.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 

Cash Subsidy or Tax Credit?.................... 24 

Administration. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 

v 
Page 

Budget ary Issues ........ 0 0 . • . . . . . . . . . . . . . . . . . • 27 

Tax Equity .............................. 0 0 00.. 28 

Conclusion ......... 0 0 ••••• 0 • • • • • • • • • • • • • • • • • • • 29 

Chapter IV Estimates of Employment Effects 

and Comparisons with Other Measures to Reduce 

Unemployment and Employment Problems................ 31 

Simulations Based on the Administration's 

Stimulus Package ......... 0 • • • • • • • • • • • • • • • • • • • • • • 31 

The Jobs Tax Credit in the Tax Reduction 

and Simplification Act of 1977--H.R. 3477 ..... 0. 33 

Appendix A (To Chapter II) Economic 

Side Effects of Employment Subsidies .. 00........ 35 

Appendix B-1 (To Chapter III) Employment 

Subsidy Legislation in 95th Congress ...... o..... 37 

Appendix B-2 (To Chapter III) The WIN 

Program: A Structurally-Oriented Private 

Sector Employment and Training Program.......... 49 

Appendix C (To Chapter IV) Results From 

And Cautions About Some Studies of 

Employment Subsidies ...................... 0 •• 0 • • 55 

Hamermesh Study .. 0 • 0 • 0 0 •• 0 0 •• 0 • 0 0 • • • • • • • • • • • • • 55 

Large-Scale Econometric Model Simulations .. 0 • • 59 

Fethke and Williamson Study............ ... .... 62 

vi 
LIST OF TABLES 

Page 

A-I. Employment Subsidy Legislation 

Presented in the 95th Congress................ 40 

A-2. Fiscal Year 1976 WIN Program Data...... .. ..... 52 

A-3. Impacts of a Ten Percent Wage Subsidy. . ... .... 57 

A-4. Impacts of a $3/Day Wage Subsidy.............. 57 

vii 

SUMMARY 

During early 1977, both the Congress and the 

Administration considered ways to provide more jobs 

through stimulus to the private sector. In addition to 

the usual sorts of tax reductions and expenditure 

increases, attention was focused on subsidies to induce 

businesses to employ more workers. President Carter 

included an employment tax credit in his economic stimulus 

package, an alternative was passed by the House, and the 

Senate Finance Committee produced a modified version of 

the House bill. All three were designed to have an 

estimated revenue cost of about $2.4 billion. 

Alternative Employment Subsidies 

The President proposed a general subsidy applicable 

to all private sector employment; it would offer a credit 

that would reduce income tax liability by 4 percent of 

the employer's social security contribution (a maximum of 

about $40 per worker, per year). The credit would be 

refundable to the extent that it exceeds tax liability. 

Under the President's proposal, firms would be allowed 

an option to the employment tax credit--an investment 

tax credit increase to 12 percent from 10 percent. 

The House passed a more restricted type of subsidy, 

the Jobs Tax Credit included in H.R. 3477, The Tax 

Reduction and Simplification Act of 1977. The Jobs Tax 

Credit is intended to subsidize only increases in employment and places limits on the amount of credit available 

per firm and per employee. This tax credit would be 40 

percent of the first $4,200 of annual wages (that is, a 

maximum of $1,680 per employee) to employees hired in 

excess of a threshold of 103 percent of the firm's employment base in the prior year, up to an annual maximum 

credit of $40,000 per taxpayer. 

The Senate Finance Committee version reduced the 

subsidy rate to 25 percent of the first $4,200 of annual 

wages (a maximum of $1,050 per employee) to employees 

ix 

87 -886 0 - 77 - 2 
hired above the threshold. The Finance Committee reduced 

the incentive further by subtracting the amount of the 

credit from the deduction employers may take for wage 

payments. The Finance Committee liberalized the credit, 

however, by removing the credit limit per firm. In 

addition, firms were allowed the option of an increase 

in the investment tax credit as under the President's 

proposal. 

Although there is a wide variety of employment tax 

credits, they all have a common purpose: to reduce labor 

costs of employers without reducing wages received by 

workers, and thus to encourage more employment. Ideally, 

an employment subsidy would induce a large number of jobs 

at low budgetary cost, would do so quickly enough to 

operate as an effective countercyclical employment stabilizer, would be administratively simple, and would not 

have undesired economic side effects or hidden costs. 

Unfortunately, an ideal employment subsidy does not 

exist (nor does an ideal type of any other subsidy). 

Because the subsidy seeks to induce firms to increase 

employment, some time will be required for business 

managers to respond to the incentive. Furthermore, a 

large permanent cut in wage costs is probably necessary 

to induce businesses to change to more labor intensive 

production methods. A large subsidy per worker would 

either imply sizable budget costs or require some limits 

on eligibility for the subsidy. Eligibility limits would 

increase administrative complexity. The lags are probably 

greater and the response weaker when sales prospects are 

low or uncertain--which is when the subsidy would be 

needed most. 

General Subsidies. A general employment subsidy 

program applicable to all employment would pose the least 

administrative difficult But a general employment 

subsidy would be spread over the entire work force, and 

thus the subsidy level must be a small proportion of the 

wage if program costs are to be kept low. President 

Carter's proposed employment subsidy would reduce tax 

revenue by about $2.4 billion annually while reducing wage 

costs by less than 0.25 percent. It is doubtful that a 

general employment subsidy of this amount would have a 

noticeable direct impact on employment. Such a subsidy 

could be expected to have about the same indirect 

x 
employment effect as a business tax cut that increases the 

federal budget deficit by the same amount. 

Marginal Subsidies. Marginal employment subsidies 

that restrict the subsidy to increases in a firm's work 

force have been proposed as a means of enhancing the 

direct job-creation effect. A marginal subsidy would 

reduce, but not eliminate, windfall payments (payments 

made for increases in employment that would have occurred 

without the subsidy), and thus would create more jobs 

per dollar of subsidy. There do not appear to be objective and readily administrable procedures for identifying 

employment decisions that would not have been made in the 

absence of the credit. 11 

The Jobs Tax Credit passed by the House and the 

Senate Finance Committee approximates this elusive result 

by specifying a threshold of 103 percent of the firm's 

prior year employment, as measured by its wage base subject to the Federal Unemployment Tax Act (FUTA). Wages 

up to a maximum of $4,200 per employee are subject to 

FUTA. Increases in the firm's FUTA wage base that exceed 

the threshold would receive a subsidy. But because annual 

employment growth in most firms is different from 3 percent, the 103 percent threshold will exclude some slower 

growing firms from participating in the program (those 

firms account for about 30 percent of employment), and 

some faster growing firms will be paid subsidies although 

no new employment is induced. Furthermore, changes in 

excess of 103 percent of a firm's FUTA wage base will be 

an inaccurate measurement of additional full-time equivalent workers induced by the subsidy because changes in 

wage rates and in the use of part-time workers will occur. 

Because of the $4,200 wage base limit, employers might 

maximize their subsidy by employing part-time rather than 

full-time workers. 

The rough estimates available suggest that a marginal employment subsidy, such as the Jobs Tax Credit, 

11 Testimony by Laurence N. Woodworth, Assistant 

Secretary of Treasury for Tax Policy, before the 

Senate Select Committee on Small Business, 

February 22, 1977. 

xi 
would result in more direct job creation per dollar of 

outlay than would a general employment subsidy. 

This gain is achieved, however, at the cost of 

several anomalous consequences of a marginal subsidy 

being tied to increases in employment. A marginal 

credit will not provide much aid during periods of weak 

demand when firms are cutting back. Firms have an 

incentive to reduce employment during a downswing, thus 

adding to the depth of a recession, and then build from 

a low base in recovery. In addition, a marginal subsidy 

will provide little, if any, aid to those firms whose 

sales are static or declining either cyclically or over 

the long run. This may intensify structural employment 

problems specific to geographic localities, industries, 

or firms. 

Selective Ceilings. Ceilings that limit the amount 

of subsidy per employee or per firm are another method 

for controlling costs. Restrictions on the applicability 

of the subsidy program may cost some businesses the 

opportunity to respond to the employment incentive, however, and supervision and auditing requirements may be 

increased. 

The House bill allowed a maximum annual credit of 

$40,000 per taxpayer. The ceiling (or "cap") limits the 

incentive for the large firms that are apt to be subject 

to the cap. The capped subsidy may provide little help 

to localities where employment depends mainly on large 

firms. The Finance Committee eliminated the cap. 

When the FUTA maximum wage level of $4,200 (or the 

Federal Insurance Contributions Act (FICA) level of 

$16,500) is used as the basis for the subsidy, administration is eased somewhat since most employers already 

keep these records and report them to the government. 

Administrative problems still remain. For example, regulations would be required for crucial but ambiguous items 

such as the treatment of new firms and part-time 

employees. Further attempts to limit these windfall 

payments would involve additional administrative costs, 

and the more elaborate the attempt, the higher the cost. 

Even though the FUTA maximum level is scheduled to 

increase to $6,000 on January 1, 1978, the Jobs Tax Credit 

xii 
would continue to subsidize just the first $4,200 of wages 

per employee. Should this happen, the reporting system 

would require adjustment, and administration would become 

more difficult. 

Categorical Subsidies. Proposals for categorical 

employment subsidies have also been offered as an 

effective means for deal with the employment problem 

of specific groups. The more narrowly defined the target 

category, however, the larger the administrative cost and 

the higher the subsidy will probably have to be to induce 

firms to participate. The disappointing results obtained 

from the WIN tax credit aimed at AFDC recipients indicate 

that employers may lack enthusiasm for categori subsidies of this kind. 

ives Be Direct 

Whether a direct subsidy is preferable to a tax 

credit depends upon the job-creating objectives of the 

program and, therefore, on the specifics of s design 

and the capability of the agency that would administer 

it. TRS is a tax collecting agency, whereas other governmen~ agencies, such as the Departments of Labor 

and Health, Education and Welfare, are more employment 

program-oriented, more familiar with the characteristics 

of certain labor markets, and may be better equipped to 

administer an employment subsidy. On the other hand, 

employers may prefer to deal with the IRS rather than the 

more program-oriented agencies, perhaps in the belief 

that an IRS program would necessarily include fewer 

administrative restrictions. 

Whether an employment subsidy is a direct outlay 

program or a tax expenditure in the form of a tax credit 

may determine who is el ible to participate. If a tax 

credit is not refundable, the full subsidy would not be 

available to firms with tax liability less than the 

subsidy. In addition. special provisions would be 

necessary to make a tax credit available to nonprofit 

institutions, whereas special treatment would not be 

necessary in a direct sub dy. 

xiii 
Because employers can deduct total labor costs from 

their taxable income, a further reduction in tax liability 

from an employment tax credit can reduce the after-tax 

cost of labor substantially, even below zero if the 

employer's marginal tax rate and the subsidy rate sum to 

more than 100 percent. This result can be avoided if 

taxpayers are able to deduct only the unsubsidized wage 

cost. 

Whether Congress can best exert proper control on 

an employment subsidy or an employment tax credit should 

be a major concern when the program is designed. In the 

past, tax subsidies have been less visible in the federal 

budget and less subject to periodic review and control. 

fects on Inflation 

Employment tax credits have been suggested as a 

means of stimulating employment, with less inflationary 

potential than a general tax cut. The extent to which 

this can occur depends on how various labor markets 

respond to the subsidy. There appears to be no evidence 

to confirm or deny the proposition that employment tax 

credits are less inflationary than general fiscal 

stimulus. 

Estimated Effects of Employment Stimulants 

Unfortunately, federal tax or expenditure policy 

changes of only a few billion dollars rarely produce 

employment impacts large enough to be measured with any 

confidence by any technique or model, and therefore it 

even more unlikely that estimated differences among 

such changes are meaningful. As might be expected, the 

simulated effects on unemployment and inflation show 

little basis for choosing among the alternative ways to 

spend $2.4 billion. 

Analysis and simulations suggest that a general 

employment tax credit, such as the President's proposal, 

would produce at least as large an increase in GNP as a 

general business tax reduction of the same amount. Such 

a program not as easy to administer because of the 

xiv 
extra step in the auditing process and because of the 

optional 2 percent increase in investment tax credit. 

But, because of the option, the proposal would provide 

more tax reI f to more businesses than would either 

an increase in the investment credit or an employment 

tax credit without the option. 

The Jobs Tax Credit has approximately the same 

revenue cost as the Carter proposal. It may induce more 

jobs than the Carter proposal, although this is not 

certain. With the Jobs Tax Credit there is a loss of 

simplicity as compared with the Carter proposal, and the 

business tax relief is less general because of the 

threshold feature. The Jobs Tax Credit has many special 

features that cannot be accounted for in the CBO 

Multipliers Model 2/ or in the large-scale econometric 

models commonly used for fiscal policy simulation. Using 

a variety of methods, none of which are precise, CBO 

estimated that as a rough guide the Jobs Tax Credit 

passed by the House would probably yield a slightly 

larger reduction in unemployment than would the Carter 

proposal. The Senate Finance Committee version of the 

Jobs Tax Credit would tend to have less of a direct 

employment effect than would the House version. 

As between an employment tax credit and an 

alternative such as public service jobs, there is little 

to choose based on the simulated fects on unemployment 

and inflation. Another basis for comparison is that an 

employment tax credit helps private businesses, whereas 

the direct effects of public service jobs are in the 

government sector. Whether either of the types of jobs 

would survive the removal of federal spending is an 

important and unresolved issue. 

~/ See Chapter IV for a discussion of the model. 

xv 

CHAPTER I INTRODUCTION 

By historical standards, unemployment in the early 

months of 1977 remains h Both the Congress and the 

Administration have argued that more jobs in the private 

sector might result from employment subsidies, usually in 

the form of tax credits. One tax credit--equal to 4 percent of the employer's social security tax--was suggested 

by President Carter. Another--the Jobs Tax Credit--has 

been passed by the House and modified and passed by the 

Senate Finance Committee. Employment tax credits or 

subsidies are a new and as yet generally untried mode of 

fiscal stimulus, and thus our understanding of their 

potential effects is highly uncertain. 

Employment subsidies have been offered as ways to 

accomplish three objectives: 

o Lessen the high overall rate of 

unemployment; 

o Dampen inflationary tendencies when 

stimulative policies are adopted; and 

o Reduce the disproportionately high levels 

of unemployment and underemployment that 

persist among some groups of workers 

during both good times and bad. 

This paper deals with employment tax credit proposals 

by focusing on several que ions: 

87-886 0 - 77 - 3 

o What economic fects can be expected 

from different types of employment 

subsidies? 

Is an employment subsidy more 

effective as a countercyclical 

employment stabilizer than other 

policies such as a general tax 

reduction? 

1 
Are these subsidies especially 

effective in retarding inflationary 

pressures? 

Are they particularly useful in 

solving structural employment 

problems? 

o What design and administrative problems 

can be anticipated for various employment subsidies? 

Is there an advantage in structuring 

the employment subsidy to work 

through the tax system? 

2 
CHAPTER II ALTERNATIVE EMPLOYMENT SUBSIDIES 

There is a wide variety of possible employment 

subsidies. All have one common purpose: to encourage 

more employment by reducing labor costs without reducing 

wages. The extent to which any subsidy will achieve th 

purpose is an open question because response to the subsidy among businesses and workers is difficult to predict. 

The following analysis explains how employment subsidies 

work and is intended to give some rough guides to their 

effect on employment and inflation. It also provides 

some of the background needed to understand the problems 

involved in designing and administering an employment 

subsidy. These difficulties are discussed more fully in 

Chapter III. 

GENERAL EMPLOYMENT SUBSIDIES 

President Carter's proposal to allow a tax credit 

for 4 percent of the employer's share of the social 

security tax is one example of a general employlDent 

subsidy. 1/ It would cost about $2.4 billion in revenue 

and reduce wage costs by approximately 0.25 percent. 

Because general employment subsidies apply to all covered 

wages without any threshold or ceiling, they would be 

relatively simple to implement. 

Effects on Employment 

In the Immediate Short Run. Despite the reduction 

in labor costs that a general employment subsidy would 

offer, a business might not hire more employees immediately. The extra funds provided by the subsidy could 

1/ Businesses are offered the option of taking a two 

percentage point increase in the investment tax 

credit (to 12 percent from the current 10 percent). 

3 
simply be retained by the firm until managers take time 

to revise employment or pricing plans. A firm is less 

likely to respond to it by quickly increasing its work 

force, canceling planned layoffs, or changing its pricing 

plans if it faces weak or uncertain sales prospects, if 

the subsidy is temporary, or if it is a relatively small 

fraction of the wage. Such factors make the probability 

of employment changes less certain. A general subsidy 

spread over the entire work force would likely be a 

small fraction of the wage if budgetary costs are to be 

kept within reasonable limits. For example, a $10 

billion subsidy would amount to less than a 1 percent 

reduction in wage costs. 

If a general employment subsidy does not directly 

increase employment--by inducing changes in production or 

sales plans--it may do so indirectly by raising aggregate 

demand. If the payments provided by a general employment 

subsidy were simply retained by a firm, then they could 

be expected to have about the same indirect employment 

effect as a general business tax cut of the same amount. 

Businesses would have more funds to spend on investment 

or to distribute among owners; this would increase 

aggregate demand and eventually reduce unemployment. The 

resulting increase in employment, however, would be 

attributable to the stimulative effect of the rise in the 

deficit rather than the particular employment-oriented 

form of the subsidy. 

Within a Moderate Adjustment Period. In the 

slightly longer run (six to 18 months after enactment), 

firms are more likely to find it profitable to adjust to 

reductions in unit labor costs by hiring more workers and 

producing more output for sale at lower prices. The subsidy might also encourage businesses to modify production 

methods to use relat y more labor and less capital 

equipment. These changes would require time, and their 

magnitude would depend on the strength of the demand for 

the firm's product, on general business conditions, and 

on the size and permanence of the subsidy. In particular, 

modifications in production methods that significantly 

alter the relative use of labor or the skill level of 

workers usually requ a long adjustment period and a 

sizable inducement. 

4 
A given wage subsidy, however, would not necessarily 

reduce unit labor costs by the amount of the subsidy and 

thus may be less effective than it would appear to be at 

first glance. Newly hired workers may require costly 

training. At the bottom of a recession, there may be 

more employees available; but employers may not hire 

because of poor business conditions. As recovery begins, 

employers will hire, but the available unemployed may be 

less suitable to fill the job openings. Employers may 

then incur training costs, which consume the subsidy and 

diminish its net value and thus its incentive effects. 

Also, competition for more skilled workers or wage 

negotiations may raise wages and inhibit increases in 

employment, especially during recovery periods. The 

more the subsidy induces wages to be raised, the less it 

can be distinguished from a general income tax cut in its 

countercyclical effect on employment. 

This reasoning suggests that a general wage subsidy 

is not much different from a general tax cut in its 

effect on stabilizing employment levels. 

Effects on Inflation 

Some observers argue that employment subsidies are 

attractive because they raise demand by reducing costs 

rather than by stimulating demand directly and that they 

thus tend to be less inflationary than traditional fiscal 

stimulants. By reducing unit labor costs, a general 

employment subsidy may provide an initial reduction in 

the price level, and could thereby reduce inflationary 

expectations and hence the path of future pr The 

ability of employment subsidies to accomplish this, however, is limited by the way wage rates change as labor 

markets respond to the subsidy. Such responses will vary 

with general business conditions, being weaker during 

downturns than upturns. During a recovery, if a general 

employment subsidy reduces the cost of all types of 

labor proportionally, it will neither reduce demand for 

trained workers nor encourage a faster upgrading of less 

skilled workers than would an income tax cut. But unless 

the demand for workers can be redirected from tight labor 

markets to those in which wages are not so likely to be 

raised, the overall increase in the demand for labor will, 

5 
during a recovery for example, raise wages and increase 

inflationary expectations. In that case, a general 

employment subsidy exerts inflationary demand pressure 

similar to that resulting from any stimulative fiscal 

policy. 

Effects on Structural Employment Factors 

Because only a small fraction of a general employment subsidy would be paid to employers of hard-to-employ 

individuals, it would be only a weak factor in directly 

reducing the so-called "structural employmentfl problems. 2/ For example, unemployment caused by the minimum wage ~/ could be mitigated by a wage subsidy, but not 

perceptibly if the subsidy amounts to only a small 

share--l or 2 percent--of the wage bill (and such a 

subsidy would have a budget cost of $10 billion to $20 

billion). A general wage subsidy is not nearly as well 

suited to alleviating structural employment problems as 

is a subsidy focused on hard-to-employ groups of workers. 

It is argued, however, that even a subsidy focused on 

such groups will not be effective unless business conditions are strong. Also, a general employment subsidy 

~/ Structural characteristics of the labor market include 

low demand for low-skilled workers, geographic 

imbalances of economic growth, job availability vs. 

potential workers, race and sex discrimination. These 

characteristics restrict the employment possibilities 

of some groups of workers. For a discussion of these 

problems, see Public Employment and Training 

Assistance: Alternative Federal Approaches, CBO 

Budget Issue Paper, February 1977. 

~/ There is a consensus that the minimum wage reduces 

employment somewhat below what it would otherwise be; 

but there is no consensus on the magnitude of its 

effect on employment or on the availability of 

training and experience. For further discussion, 

see Policy Options for the Teenage Unemployment 

Problem, CBO Background Paper No. 13, September 21, 

1976-.-

6 
can, by stimulating the economy, help curtail the 

widening of unemployment differentials that afflict the 

hard-to-employ during recessions. 

MARGINAL SUBSIDIES--SUBSIDIZING INCREASES IN EMPLOYMENT 

Some proposals would provide subsidies only for 

employment (or amount of payroll) in excess of an 

established threshold--that is, "marginal" subsidies. 

In March 1977, the House passed the Jobs Tax Credit 

bill, containing a nonrefundable tax cred of 40 

percent--25 percent in the Senate Finance Committee 

version--of the first $4,200 in wages for each worker 

employed in 1977 in excess of a threshold of 103 percent 

of the employer's 1976 employment base--measured in dollar 

terms by the employer's total Federal Unemployment Tax Act 

(FUTA) tax base. The Senate Finance Committee further 

reduced the incentive by requiring employers to subtract 

the credit from the wage costs they deduct in computing 

their tax liability. In the House version, the total 

credit to each taxpayer is limited to $40,000 per year; 

the Senate Finance Committee eliminated th ceiling. 

The Senate Finance Committee version also allows firms 

the option of a 2 percentage point increase in the 

investment tax credit--to 12 percent from 10 percent--

instead of the Jobs Tax Credit. The credit applies also 

in 1978, with the base period moving to 1977. 

Ideally, a marginal subsidy would be paid only for 

increases in a firm's work force that otherwise would not 

occur. As a result, the potential number of new jobs per 

dollar of subsidy would be greater than when payment is 

based on total employment--such as in the case of a 

general employment tax credit. In practice, however, a 

threshold will not guarantee the creation of net new 

jobs. For example, if a firm that qualifies for the 

credit simply uses the subsidy to hire workers away from 

a firm that does not qualify, no net new job creation has 

resulted from the sUbsidy. Nor will the threshold completely limit the subsidy to just those jobs induced by 

the program. The 103 percent threshold in the Jobs Tax 

Credit is an attempt to deny the credit to those increases 

that would occur as a result of normal growth without the 

7 
subsidy. The less perfectly the threshold works, the 

smaller is the number of induced jobs compared to the 

total number of subsidized jobs. The less the subsidy 

is limited to induced jobs, the less it does to minimize 

the inflationary tendency that may accompany more general 

fiscal stimulus. In other words, the more windfall payments are generated, the more the marginal subsidy produces re ts similar to a nonmarginal employment subsidy 

or a general fiscal stimulant. However, minimization of 

windfalls is not an end in itself; if the subsidy 

designed largely to avoid windfalls but is only a minor 

inducement to add workers, subsidy payments will be 

negligible and will not provide significant stimulus. 

Moreover, attempts to limit windfalls will involve 

administrative costs--both to the government and 

employers--and these are discussed in Chapter III. 

The Base and Job Creation 

Because the base must be set arbitrarily, it is 

incorrect to assume that all increments to a firm's work 

force have been caused by the incentive payment. To 

illustrate, if the base is set at the level of employment 

in a recession year, some increases in excess of the base 

would normally occur in a recovery (without any subsidy), 

but they would be eligible for the subsidy. Longer-term 

growth due to increased demand for a firm's products, 

though unrelated to the subsidy, can also be misread as 

induced employment (jobs created by the program) and be 

rewarded by such an incentive system. On the other hand, 

the threshold can exclude some firms whose growth is 

below the threshold. The 103 percent threshold would 

exclude firms that account for about 30 percent of total 

employment from participating in the Jobs Tax Credit. 

Anomalies of Larger Subsidies for Increased Employment 

The essence of a subsidy to induce additions to the 

work force is that it provides larger benefits the more 

employment is increased. This characteristic has several 

anomalous consequences. While this incentive feature is 

a highly desirable qual y during recovery from recession, 

it will not provide much aid during periods of weak 

8 
demand when firms are cutting back. 4/ That is, with 

a shrinking employment base, no subsIdies will be paid. 

Furthermore, firms have an incentive to reduce employment during a downswing and then build from a low base 

in recovery to enlarge their subsidy receipts. This may 

actually increase rather than decrease swings in employment levels. 

Because geographic regions, industries, and 

individual firms experience changes in demand and employment needs at different times--rather than moving in 

cadence--a marginal subsidy will allocate relatively 

less aid to those regions, industries, and firms that 

are declining or recovering or growing most slowly. In 

1975, for example, automobile manufacturing firms that 

were recovering from the recession would have benefited 

substantially from a marginal employment subsidy, whereas 

those that were not yet into a recovery would have gained 

little. Although less well documented, the same unequal 

pattern of distribution would seem to apply over the 

entire economy. 

Differences in longer-run growth--in addition to 

cyclical conditions--can also affect the distribution of 

subsidies resulting from a marginal employment tax credit. 

Compared to businesses with stable or declining employment, more rapidly growing firms would receive larger 

amounts of aid under a marginal employment subsidy. This 

result tends to intensify structural employment problems 

concentrated in some geographic localities, industries, 

or firms. For example, a northeastern shoe manufacturer 

would likely receive relatively less help than a rapidly 

growing electronics parts producer in the southwestern 

region of the United States. 

Variable-Base Marginal Subsidies 

More elaborate marginal employment subsidies have 

been proposed--one, for example, by Senator Bentsen--in 

i/ In this situation, the base could be set below previous employment levels, but doing so would provide 

large windfalls for those firms whose employment is 

not declining. 

9 87.886 0 - 77 • 4 
an effort to provide an effective countercyclical 

incentive. Instead of remaining fixed, the employment base is varied according to general business 

conditions, lowering it (for example, to 90 percent of 

the prior year) to provide stimulus during recessions 

and raising it (perhaps even above 100 percent) when 

inflationary pressures build. 

An attractive feature of this idea is that businesses 

are provided with an incentive not to fire workers 

during a recession; as the base is reduced, workers 

already employed above that threshold are counted as 

eligible in computing the firm's sUbsidy. But successful 

application of this idea requires a more delicate sense 

of timing of economic events than has been demonstrated 

in the past. 

One approach to the timing problem is to establish 

a rule by which the base automatically varies countercyclically--for example, with the overall rate of unemployment. But the design of a successful general rule 

presupposes a solution to the timing problems that tend 

to frustrate even the simplest general employment subsidy when it is used as a countercyclical employment 

stabilizer. The problems are even more pronounced for 

a rule that applies to a marginal subsidy because in 

this case the rule must account for the time employers 

require to decide whether it is profitable to hire 

additional labor in response to the subsidy, and it must 

also embody a prediction of the extent of the response, 

so as to include an estimate of the total dollar amount 

of the subsidy. 

Because little is known about time lags for business 

decisions, it is difficult to incorporate them into a 

simple automatic trigger to vary the base. Furthermore, 

a simple rule keyed, for example, on an aggregate 

unemployment rate cannot account for the sizable variation 

in unemployment rates among regions, industries, and 

firms at different stages of the business cycle. For 

example, firms that are slower than average in recovering 

from a business downturn may be on the verge of adding 

workers at a time when the aggregate unemployment rate 

declines and triggers a reduction in the subsidy. When 

10 
fiscal devices fail to account properly for time lags and 

the real variation in business conditions among various 

sectors of the economy, they may aggravate rather than 

smooth out the cycle. In addition, sizable administrative 

problems would be encountered in implementing such a 

program; some of these are discussed in Chapter III. 

CATEGORICAL EMPLOYMENT SUBSIDIES 

Some proposals restrict the subsidy to the employment of specific categories of workers--such as the 

chronically unemployed--and are more concerned with 

structural employment problems than with cyclical unemployment. For example, the WIN tax credit 51 is available to employers who hire AFDC recipients.- Restricting 

an employment subsidy to selected groups of workers has 

been advocated on the grounds that it will alleviate 

structural employment problems, contribute to a reduction 

in the overall unemployment rate, and do so with less 

inflation than more general fiscal instruments. Economic 

aspects of this discussion are considered in this section, 

and difficulties in administering categorical employment 

subsidies are considered in Chapter III. 

Alleviating Structural Employment Problems 

An employment subsidy restricted to groups of hard-

. to-employ workers, such as those unemployed for over 26 

weeks and teenagers, 61 may alleviate structural employment problems. Such a subsidy lowers the cost of employing the selected group--absolutely and relative to 

others--and thereby encourages firms to use more of the 

designated category. 

~I The WIN tax credit is described in detail in Appendix 

B-2. 

£1 Chapter III discusses administrative problems in 

defining such class ications and focusing a subsidy 

on them. 

11 
Whether businesses will respond to a categorical 

employment subsidy and use subsidized workers rather 

than unsubsidized workers or capital equipment depends 

on many economic and administrative factors. A subsidy 

is more likely to induce hiring of the selected group 

if business. managers perceive subsidized workers as substitutes for unsubsidized workers or machines, and if 

it is easy for managers to identify and employ prospective 

workers qualified under the subsidy, while keeping 

administrative costs low. Replacement of unsubsidized 

workers with subsidized ones is less likely the more the 

firm has invested in training its current workers and the 

higher the cost of finding and employing workers who 

qualify for the subsidy. Search and administrative costs 

to the firm are usually higher the more narrow is the 

category being subsidized. 

Experience with the WIN tax credit indicates that 

employers may have little enthusiasm for categorical 

subsidies, but extrapolation of the effects of this program to other categorical subsidies should be treated 

with caution. Two reasons have been suggested for this 

lack of enthusiasm: (1) employers may view eligible 

workers as poor risks; that is, eligibility for a subsidy 

is a stigma that reinforces the view that the worker has 

productive potential lower than the cost of employment 

even with the subsidy and (2) the program may entail too 

much red tape. 11 

How the employer responds to a categorical employment 

subsidy determines the effectiveness of the subsidy in 

remedying structural employment problems. These problems 

endure not only because of characteristics of workers 

themselves, but partly because of the characteristics of 

the jobs held by the hard-to-employ. Continued experience 

in jobs characterized by low productivity, unstable 

employment, and few training opportunities reduces the 

potential that these workers will become employed in 

"better" jobs at a later date. 

11 Daniel Hamermesh, Indirect Job Creation in the Private 

Sector: Problems and Prospects, unpublished manuscript, 

dated March 1977, prepared for the Brookings Conference 

on Job Creation, April 1977. 

12 
Whether or not an employment subsidy can break this 

cycle depends upon whether the employer finds it 

profitable to use the subsidy to provide targeted groups 

with training and productive job opportunities. This 

upgrading is more likely if the subsidy is large, of more 

than temporary duration, and if the employer's labor needs 

are growing. If, on the other hand, the employer uses 

the subsidy only to provide employment opportunit s 

similar to those currently facing the hard-to-employ, the 

subsidy will not alleviate the long-run problems these 

workers. Furthermore, a categorical subsidy, by lowering 

the price of unskilled workers relative to skilled workers 

and capital equipment, may encourage businesses to shift 

toward unskilled production methods, thereby diminishing 

the subsidy's impact on employment problems. 

Reducing Aggregate Unemployment 

The level of employment will not increase if the 

firing of an unsubsidized worker accompanies the hiring 

of a subsidized one, but the distribution of employment 

opportunities and unemployment may become more equal--

which may be a policy goal itself. The more rapid the 

rate of economic growth and therefore the growth of 

employment needs, the more subsidized workers can be 

hired without laying off unsubsidized ones. To the 

extent this occurs, both the overall rate of unemployment 

will decline and the distribution of unemployment among 

various groups of workers will become more equal. 

Lessening Inflationary Tendencies 

By shifting demand for labor away from skilled 

labor markets that are relatively tight and toward 

markets with greater unemployment, a categorical employment subsidy could lessen the inflationary tendenc s 

of general fiscal stimulus during recovery periods. Less 

pressure on wages and hence prices will result if, compared to skilled labor, the supply of subsidized labor 

is more responsive to wage increases. There appears to 

be no evidence, however, to confirm or deny the proposition 

that a categorical employment subsidy would be less 

inflationary than general fiscal stimulus. 

13 

CHAPTER III PROGRAM DESIGN AND ADMINISTRATION 

To design a successful employment subsidy, 

administrative considerations must be weighed simultaneously with economic considerations. Two aspects of 

program design and administration are important. The 

first results from efforts to focus the subsidy and 

increase its job-creation effectiveness. Restrictions 

on the applicability of an employment subsidy have the 

potential to increase the number of new jobs initially 

created per dollar of subsidy. But these restrictions 

complicate program design, and the complexity may not 

only increase the administrative costs to both the 

government and firms, but also, in fact, reduce the jobcreating effectiveness of the subsidy. The second 

aspect is whether the program should be administered as 

a direct budget outlay or as a tax credit. 

ADMINISTRATIVE COMPLEXITY, JOB-CREATING EFFECTIVENESS 

AND PROGRAM COSTS 

Restrictions designed to improve the effectiveness 

of an employment subsidy by limiting its applicability 

will increase administrative problems for both the 

government and subsidy recipients. In designing an 

employment subsidy, the Congress should consider the 

tradeoff between job-creating effectiveness and the 

ease of program administration and ask whether the 

increased effectiveness, if any, of a more complicated 

program is worth the additional cost. 

General Employment Subsid~ 

The more general a subsidy, the less the administrative complexity. A program that applies to all 

employment would pose the least administrative difficulty 

because it would involve few restrictions requiring 

regulations, and consequently program interpretation, 

compliance, and enforcement would be facilitated. A 

subsidy based on the employer's social security I 

15 
contributions, for example, would present little complexity 

and could be administered with little additional cost to 

either the government or participating firms because 

already existing auditing procedures would probably not 

have to be increased substantially. 

Employment Subsidies with Limited Eligibility 

Limitations to general applicability will, by their 

very nature, introduce problems of definition and interpretation that may require numerous regulations and 

extensive government involvement to monitor applicants 

and participants and enforce the restrictions. Thus, the 

more complex is an employment subsidy program, the higher 

will be the government's administrative costs. These 

costs add to the total cost of the employment subsidy 

program and thus to the cost of each new job. 

Increased program complexity also affects the 

behavior of prospective subsidy applicants. First, the 

more complex the program, the more costly the firm's 

record keeping and other administrative processes, such 

as recruitment. In addition, subsidies that apply only 

to certain individuals normally require more government 

supervision and auditing, Many firms find this interference bothersome as well as an invasion of privacy. 

As a result, the net benefits of the subsidy to the firm 

may be substantially less than the amount specified in 

the statute, and this difference may reduce program 

participation. 

Eligibility restrictions also complicate the process 

of adequately informing prospective participants about 

programs to stimulate employment. A recent study found 

that because large firms typically separate their hiring 

and accounting departments; the hiring departments were 

uninformed about the WIN program. 11 Similarly, small 

1 Institute for Manpower Program Analysis, Consultation, 

and Training, Interim Report on the Study to Assess 

WIN and Welfare Tax C~edits, prepared for the U.S. 

Department of Labor, 1975. 

16 
firms often lack the managerial capacity to become 

informed about and utilize new tax advantages, and such 

lost opportunities would dilute the effectiveness of the 

program. 2/ These problems are often cited as reasons 

why the WIN tax credit has been little used. Most of the 

employment tax credit leg lation presented to the 95th 

Congress at least as complex as the WIN tax credit, 

and may have the same administrative problems. 

Ma~'ginal Subsidies 

A marginal subsidy would create more administrative 

problems than a general employment subsidy. The investment tax credit, for example, does not have a threshold 

requirement in part because of the difficulty in 

managing a program that subsidizes only increments above 

a base level. It is no simple task to inform some 

potential applicants--small proprietorships lacking 

accounting and legal counsel--about how a marginal employment subsidy actually works, and it may be equally difficult to monitor the attempts of other firms seeking to 

manipulate the program. Defining a marginal subsidy's 

base so that it works in a practical way is a major 

administrative obstacle. For example, what is the 103 

percent threshold for a firm with two employees? ~/ 

~/ Of course, the larger the subsidy the more likely it 

is that information about the program will be widely 

disseminated. 

~/ Note that about 42 percent of about 3.4 million firms 

have nine or less employees, so specific regulations 

for small firms would be essential. The Jobs Tax 

Credit bill (H.R. 3477) deals with this problem by 

measuring the firm's employment base by the amount of 

its payroll subject to FUTA. But, as noted in the 

following paragraph and in a following section on 

"Selected Ceilings," not all the difficulties are 

avoided. 

17 

87-886 0 - 77 - 5 
Furthermore, to assure proper application, it 

necessary to specify rules under which the credit can 

be claimed by an employer who begins business by acquiring 

an existing firm after the date the credit goes into 

effect. Otherwise, by simply closing the firm under one 

name and reopening it under another, employers could 

increase the number of their workers eligible for the 

subsidy; a bookkeeping change would increase the number 

of workers eligib for a marginal subsidy without 

actually increasing the firm's employment. Also, sale 

of part of a firm could cause a loss of subsidy even 

though employment increased above the threshold in the part 

of the business that was retained. Specific regulations 

regarding eligibility for the credit are required in the 

case of mergers, acquisitions, divisions, and similar 

transactions. 

It is difficult to assure accurate measurement and 

reporting of a firm's base period employment. Unemployment insurance and social security records are the best 

records of an individual's employment. Even these payroll tax data, however, can provide only an approximation 

to full-time equivalent employment because some employment is not reported and some would be mistakenly counted 

more than once. 4/ An average employment level would be 

difficult to derIve from this information even though 

total employment might be available. Modifying either 

set of records to serve more adequately as the reporting 

base for a marginal employment subsidy would be expensive 

and time consuming for both the government and participating firms. 

i/ For calendar year 1977, the FUTA and FICA (social 

security) tax bases respectively cover only the first 

$4,200 and $16,500 of each employee's annual wages. 

Therefore, an employee may reach the maximum working 

less than a year for firm X, transfer to firm Y, and 

be counted on the rolls of both firms. Another 

employee may make the reverse move--from company Y 

to X--and will also be recorded on the rolls of both 

companies. In addition, most but not all firms are 

covered under the FUTA and FICA systems. 

18 
Similarly, it is difficult to measure and report 

annual changes in employment. In contrast, the dollar 

amount of total payroll is readily available, but a 

subsidy based on a payroll increase may subsidize a rise 

in wages without any increase in employment. The Jobs 

Tax Credit deals with this problem by using the unemployment insurance base. 

Some of the pending legislation (see Appendix B-1) 

would deny the credit to firms for new employees if they 

displaced other workers. This requirement would be very 

difficult to enforce because the reason for discharge of 

an employee would be hard to determine. 

The mechanics of establishing a firm's employment 

base and measuring changes from that base should be 

easily understood. If they are not, businesses may reduce 

their participation in a program rather than accept the 

government supervision associated with effective auditing 

and enforcement procedures. 

Variable-Base Marginal Subsidies 

A variable-base margin~l subsidy involves additional 

difficulties. For reasons discussed above in Chapter II, 

if it is not properly designed, its operation may aggravate 

rather than alleviate cycles in the economy. Furthermore, 

it would not be easy to administer. How and wnen the 

base, or threshold, should vary must be clear. Because 

a variable-base subsidy would be designed as a countercyclical tool, adjustments in the threshold would likely 

be keyed to the unemployment rate. Movements in the 

base--upward when the unemployment rate falls and downward when it rises--would require the agency that 

administers the subsidy to keep firms posted currently 

on variations in the threshold; the more frequent the 

variation, the closer the supervision. Participating 

firms would confront sizable accounting and management 

tasks in keeping abreast of and responding to changes in 

terms of the subsidy, especially if there are several 

variations in the base during one credit period. 

19 
Selective Ceilings That Limit the Amount of the Subsidy 

Adequate enforcement of a program that places 

selective ceilings on subsidies will require written 

regulations that are subject to interpretation and 

appeal. Thus, the subsidy will involve more government 

supervision and auditing than a program without such 

constraints. In addition, such ceilings, especially when 

combined with a threshold requirement, make it more complicated and costly for businesses to comply with the 

rules and thus may reduce participation, particularly by 

smaller firms that would benefit most from the subsidy. 

Commonly mentioned selective ceilings are: 

o Limiting the dollar amount of 

subsidy per firm; 

o Limiting the number of 

employees per firm; 

igible 

o Limiting the dollar amount of 

subsidy per individual; 

o Phasing out the subsidy with a 

variable ceiling; and 

o Turning off a marginal subsidy 

when employment reaches a certain 

percentage of previous employment. 

Most of the employment subsidy legislation pending in the 

95th Congress includes at least one of these. 

To administer properly a ceiling (or cap) on the 

dollar amount of subsidy per firm, it necessary to 

define the term "firm" with rules that preclude employers 

from increasing their subsidy by dividing a large firm 

into several smaller ones. The House version of the Jobs 

Tax Credit included a $40,000 cap per taxpayer and 

specified rules for computing the amount of the credit when 

firms change form or change hands. In implementing the 

rules the Treasury Department would have to issue regulations that would be administered by the IRS. The 

Senate Finance Committee eliminated the cap in its version. 

20 
A cap on the maximum credit per firm limits the 

incentive for the large firms that are apt to be subject to the ceiling. For example, the $40,000 maximum 

in the House bill would eliminate the incentive for 

large firms that account for about 36 percent of employment. 5/ Such a subsidy may provide little help to 

localities where employment depends mainly on large firms. 

The lower the maximum, the more firms will refrain from 

participation because of overhead costs associated with 

the program. 

The same difficulties apply to a ceiling on the 

number of employees per firm, but, in addition, distinctions among employees may also be involved. For 

example, the treatment of part-time employees as compared to full-time employees may require special rules. 

A ceiling on the amount of subsidy per employee may 

also cause administrative difficulties for both participants and government. The administration of a subsidy 

with limits on the amount per employee is simplified by 

specifying the subsidy as a percentage of either the 

unemployment insurance base or the social security tax 

base. These bases are readily available because firms 

already keep records and submit reports on them. In 

contrast, a subsidy of a flat $5 per worker-day would 

presumably require the complication of specifying and 

reporting full-day equivalents. Even the unemployment 

insurance and social security tax bases present some problems because they are both scheduled to change. If the 

wage maximum for the subsidy is not altered commensurately, 

neither existing reporting system could be used without 

alteration. 

A low subsidy base limit--such as the Jobs Tax 

Credit FUTA base of $4,200 per employee--focuses the subsidy on low-wage employees and part-time rather than 

5 About half of the employment in manufacturing 

industries, for example, is in firms with over 3,000 

employees, and an employment increase of less than 

1 percent would push such firms over the ceiling and 

thereby limit the amount of the credit. 

21 

.. L 
full-time or overtime workers, and thus favors retail 

trade and services, including legal, medical, and 

accounting establishments. 61 A low base also offers 

an inducement to "churn" low-skilled workers, that is, 

to employ a worker up to the $4,200 maximum, fire the 

worker and hire another, and repeat the procedure. To 

prevent churning, the House bill included several safeguards. The major one was eliminated by the Senate, at 

the request of the Treasury Department, on the grounds 

that it was not administratively feasible for the IRS 

to determine whether an employer replaced one employee 

with another in order to obtain a credit. An increase 

in the subsidy base would change the focus of the subsidy more toward full-time, average-wage workers. For 

example, the subsidy could be based on the social 

security wage base limit of $16,500. One disadvantage 

of doing so is that wage inflation could be misread as 

an increase in a firm's employment. For example, a 10 

percent wage increase from $15,000 to $16,500 could not 

be distinguished in this base from a 10 percent increase 

in employment. With a $4,200 base, very few full-time 

workers would earn less than the maximum, and therefore 

wage inflation would not contaminate the base. 

Categorical Subsidies 

Categorical subsidies that limit the type of 

eligible individuals would pose larger administrative 

problems for both program administrators and participants than would restrictions that limit the number of 

eligible individuals. In general, it is difficult to 

rank restrictions in order of administrative difficulty 

and costliness. It is safe to say, however, the more 

narrowly the eligible individual is defined, the larger 

will be the administrative difficulty and cost. 

Some restrictions are more difficult to audit than 

others. It is easier, for instance, to determine whether 

an individual is receiving aid from another government 

!il This focus tends to counteract the disincentive of 

the <tax imposed by FUTA. 

22 
program than it is to document an individual's pattern of 

employment. Individual employment information is 

necessary for administering a marginal subsidy for the 

chronically unemployed. Such a program may require that 

eligible employees be unemployed for, say, six months 

prior to the subsidy and remain on the job for at least 

one year. If designed as a tax subsidy, the burden of 

administering such restrictions falls on the audit and 

enforcement staff of the IRS. 

Target groups must be carefully delineated to avoid 

problems of interpretation of rules for eligibility. 

Inadequate specification may invite more misuse (and 

perhaps fraud) than those that limit only the number of 

eligible individuals. For example, a subsidy for lowincome workers may require a definition of income for 

the individual or the family unit and an investigation 

to determine whether the workers are eligible. 

Subsidies that limit the type of eligible individuals 

also place administrative burdens on participants. A 

firm may find it costly to maintain proper employee 

records. One problem is than an eligible worker may 

cease to be eligible during the accounting period. A 

worker who is subsidized, say, because his/her household 

income is below a designated poverty level may not fit 

into that category for the entire accounting period. A 

law must specify the consequences of such a change in 

status, and an employer may be required to maintain 

records to document the change or lack of change. As 

with other subsidies that require close government supervisions, categorical subsidies increase the chance that 

prospective participants may elect not to apply for the 

subsidy. ~/ For instance, the WIN tax credit, which 

~/ The State of Maryland offered to employers a 33 percent subsidy of wages for hiring students during the 

summer of 1976. The subsidy was limited to $200 per 

student and $1,000 per firm. The maximum state 

expense for the program was limited to $250,000, but 

participation was substantially lower than expected. 

In all, only $68,000 was credited to the firms. 

23 
is available to AFDC recipients, has a very low participation rate--in part because of the large amount of 

bureaucratic red tape. ~/ 

Other Provisions 

In addition to monitoring and auditing requirements 

involving matters of eligibility, there are other provisions that shape the tasks of administering a wage 

subsidy. For example, whether the program is permanent 

or temporary may determine what type of auditing procedures should be established, both within the IRS and 

in coordination with other government agencies. Also, 

administration is complicated when a subsidy incorporates 

carryforward and carryback provisions. These features 

effectively increase the value of the subsidy and make 

the program more attractive to some prospective participants. Similarly, other programs may include provisions 

to recapture subsidies when employees or employers do 

not meet designated qualifications. This may occur if, 

say, an employer receives a subsidy for a worker who then 

quits work before a designated time period. Obviously, 

such provisions may create pressure to retain some 

employees; yet, such a provision may be necessary to 

prevent churning. 

CASH SUBSIDY OR TAX CREDIT? 

In theory, there is little difference between a subsidy paid in cash or one allowed as a tax credit. Theory, 

however, may differ from practice. This section discusses 

some of these differences. 

Administration 

A cash subsidy presumably would not be administered 

by the IRS while a tax credit would, perhaps in coordination with another department. 

8 Interim Report on the Study to Assess WIN and Welfare 

Tax Credits. 

24 
Each year the IRS has numerous contacts with 

employers. Nearly every employer has a tax adviser 

eager to explain new tax programs. The ubiquity of 

the IRS and its related profession argue strongly that 

knowledge of a tax credit will reach potential participants, at least on the employer side. 

Tax news finds its way to accounting or tax departments ofbusiness--but frequently not to their personnel 

departments. Also, if labor policy is embodied in a tax 

credit, the policy may be poorly described by the IRS 

and poorly understood by the firm's tax professional. 

Lack of understanding may lead to misuse or nonuse. The 

disappointing results of the WIN tax credit are often 

said to be testimony to these kinds of difficulties. 

Often the IRS is claimed to be very efficient and 

provide fewer administrative impediments than other 

agencies. Their reputation for efficiency in this area 

probably arises because the IRS has usually not been 

required to obtain prior proof of eligibility for a program; programs administered by other agencies frequently 

require some kind of prior certification, a burdensome 

and time-consuming process. Where similar requirements 

are demanded of the IRS, its record is little better than 

other agencies. Where prior certification is required or 

where administration is shared with another agency as with 

pensions or with the WIN tax credit, the IRS's administrative expertise diminishes. Administrative simplicity, 

then, depends in large part on the nature of the enforcement activity required by the program. In the tax area, 

it is largely audits of tax returns several years after 

they have been filed. The technique is to grant the subsidy through a tax credit and take it away later if 

eligibility cannot be proved. This is a relatively quick 

and easy process. In contrast, very few direct subsidy 

programs to business operate in this fashion; eligibility 

must be shown before the grant is made, and therefore 

these programs are more burdensome administratively. 

It is questionable whether the IRS auditing technique 

is well adapted to employment subsidies. Information 

about eligibility may not be readily available. For 

example, if a tax credit is offered only for new employees 

who do not replace employees discharged for the purpose 

25 
of obtaining the credit, the employer must maintain, 

perhaps for three years or more, records about discharges. If the credit is allowable only for employees 

who had been out of work for 26 weeks, an employer may 

be required on audit to provide the employee's work 

history. When the statute or regulation specifies the 

required records, then, unless prior certification 

assures that the necessary records are kept, the taxpayer may lose the credit even if the auditor finds 

the records only technically insufficient. But if 

documentation is not specified, lax enforcement may 

result because an auditor cannot easily dispute even 

fragmentary records. 

Also, auditing is selective. Except for the very 

large companies, less than 10 percent of all taxpayers 

are audited. Thus, there is a great likelihood that no 

enforcement activity will occur, but until the time for 

audit passes, a taxpayer may be insecure about retaining 

the benefits of the credit in questionable cases. 

An employment tax credit will add burdens for the 

IRS. The nominal cost of administration will be hidden 

in its budget. New auditing of employment tax credits 

will divert attention from other areas. But there may 

be other nonbudgetary costs that stem from the fact that 

the IRS and the tax profession may not understand labor 

policy. Unduly restrictive or overly tolerant IRS regulations may be promulgated because IRS personnel has little 

or no expertise in labor policy, But even if interpre 

tations are accurately made, they will be applied by tax 

auditors who generally have little knowledge of labor 

policy, and who will make decisions based on legal and 

accounting technicalities rather than on the policy 

sUbstance of the subsidy program. Enforcement thus may 

not only be uneven but may also be misdirected, and 

decisions denying or allowing the credit may have little 

relation to the goal to be achieved. 

Given its design, the administration of a tax 

credit is different from that accorded a cash subsidy. 

This difference in administration is often perceived as 

being fundamentally different--something unique to the 

concept of tax benefits. However, this is not the case. 

A cash subsidy program could be designed to have exactly 

26 
the same administrative features as a tax credit does 

and, therefore, would possess the same advantages and 

disadvantages. 

Budgetary Issues 

There are at least three budgetary aspects of tax 

credits that need mention. 

First, a tax credit is generally like an entitlement 

program. A budget limitation on the amount of subsidy is 

usually not specified; anyone who is eligible receives the 

subsidy. Indeed, such specification would be impossible 

except through some form of prior certification that 

would present bureaucratic delays. The Congress thus has 

less control over the budget cost than it would over the 

same program administered as a cash subsidy with a budget 

limitation. This feature often distinguishes a tax 

credit most sharply from spending programs. Without it, 

the post hoc enforcement described above could not exist, 

and some form of prior proof of eligibility would be 

required. 

Second, Congressional and executive treatment of 

tax subsidies is different from that accorded spending 

sUbsidies. A direct subsidy program presumably would 

involve the Labor Department and appropriate Congressional 

committees. In contrast, a tax credit passes through the 

tax committees and is either opposed or supported by the 

Treasury Department, often without consultation with the 

relevant leg lative committee or executive agencies. 

The consequence sometimes is policies in the revenue side 

of the budget that work at cross purposes with policies 

in the spending programs. For example, real estate tax 

shelters are often said to encourage the rapid turnover 

and poor management of rental housing, and thus conflict 

with policies of the Department of Housing and Urban 

Development. 

Finally, spending programs generally are much more 

visible than tax credits despite the publication of tax 

expenditure budgets. For those whose main concern is 

maintaining control over the budget, this aspect should 

be worrisome. For beneficiaries, visibility may be 

27 
less desirable, particularly if there is doubt that a 

strong consensus supports the program. 

Tax Equity 

Often tax credits are thought to be neutral as a 

matter of tax equ y because the amount of the credit 

does not increase simply because the taxpayer is in a 

higher tax bracket. However, tax credits generally are 

tax-free income and thus raise the same equity issue 

as other tax-free income such as interest on municipal 

bonds; the amount of tax benefit does depend on the 

taxpayer's marginal tax rate. For example, $100 of taxfree income would require $200 of before-tax income for 

a taxpayer in the 50 percent bracket (tax benefit of 

$100), but wvuld require only $125 of before-tax income 

for a taxpayer in the 20 percent bracket (tax benef of 

$25). 9 

Furthermore, when an employer receives an employment 

tax credit in addition to a complete deduction for wage 

payments, the cost of hiring an additional worker may be 

reduced to zero, or even below zero, depending on the sum 

of the subsidy rate and the employer's marginal tax rate. 

This point may be illustrated by assuming a credit of 50 

percent as it would apply to $100 of wages for two taxpayers, one in the 20 percent tax bracket and one in the 

50 percent tax bracket. The comparison is as follows: 

20% bracket 50% bracket 

taxpayer taxpayer 

Net cost of $100 of wages 

after tax deduction 100-20 = $80 100-50 = $50 

Less tax credit of $50 

(50% of wages) 50 50 

After-tax wage cost to 

taxpayer $30 0 

QI The example is just for illustrative purposes. The 

first $25,000 of corporate profit is taxable at 20 

percent. Taxpayers with income from business 

partnerships may have a 70 percent marginal tax rate. 

28 
In this example, the low-bracket taxpayer bears 30 percent the wage cost, whereas the high-bracket taxpayer 

bears none. With a 50 percent credit, any taxpayer with 

a marginal tax rate of more than 50 percent would receive 

a "negative tax, " that is, a cash grant; a taxpayer in 

the 70 percent bracket would receive $20 over and above a 

full rebate of the $100 wage cost. 

In addition, a credit confers ben its only to the 

extent there is tax liability to offset it. Thus, a tax 

credit is not offered to tax-exempt organizations; those 

taxpayers whose tax is less than the credit lose the 

excess above their tax liability. If the goal of the 

credit is to increase employment, there is reason to 

include fully these employers. This point is recognized 

in several tax credit proposals in which the credit would 

be IIrefundable," that is, paid in cash to the extent it 

exceeds the firm's tax liability. A refundable credit is 

a tax-free cash grant. The major difference is that 

administration is lodged with the IRS. 

Conclusion 

In theory, a tax credit would have exactly the same 

fect as a cash subsidy. The foregoing analysis 

suggests, however, that several differences arise if the 

subsidy is channeled through the tax system. The 

administrative burdens are much different for both the 

taxpayer and the government. The focal point of 

Congressional and executive review shifted, and tax 

equity issues are raised. 

29 

CHAPTER IV ESTIMATES OF EMPLOYMENT EFFECTS AND 

COMPARISONS WITH OTHER MEASURES TO REDUCE 

UNEMPLOYMENT AND EMPLOYMENT PROBLEMS 

A wide variety of programs and policies that affect 

unemployment and employment problems are available to 

policymakers. Estimates of how they differ in their 

impacts on employment and inflation are intensely sought, 

but, in general, the question is elusive and only 

equivocal answers can be provided. 

SIMULATIONS BASED ON THE ADMINISTRATION'S SIMULUS PACKAGE 

It is very difficult to make even rough estimates 

of the effects of particular fiscal polic s on unemployment and price levels because a large number of crucial 

assumptions are required and knowledge about these 

matters is uncertain. This is especially true for 

employment subsidies because they have never been 

implemented on a large scale in the United States. 

By making such assumptions, the short-run effects 

of the Administration's general employment tax credit 

were simulated using the CBO Multipliers Model 1/ and 

compared with alternative combinations of other-items 

in the President's fiscal year 1977-1978 "Fiscal Stimulus 

Package. l1 The impact of the employment tax credit was 

analyzed using alternative responses to the subsidy by 

employers, as discussed above in Chapter II. In the 

simulations> policy changes occur in the second quarter 

of 1977 (77:2), and the impacts of the policy changes 

are evaluated in the fourth quarters of 1977 (77:4) and 

1978 (78:4). The results would perhaps be different if 

the simulations ran beyond 78:4 or showed outcomes before 

77:4. 

The general employment tax credit produces at least 

as large an increase in GNP as a general business tax cut 

1/ A forthcoming CBO Staff Paper will describe this 

model. 

31 
of the same amount. Personal income tax cuts induce the 

largest changes in GNP in 77:4 and, in the case of a 

permanent tax reduction, the largest changes in 78:4 also. 

Tax and expenditure policy changes of only a few 

billion dollars rarely produce impacts on employment or 

inflation large enough to be measured with any confidence, 

and this was the outcome of the simulations reported here. 

The largest decrease in the unemployment rate rounded to 

just one-tenth of 1 percentage point. All of the inflation 

impacts were smaller than one-tenth of 1 percentage point. 

Thus, at the $2.4 billion level, the amount allocated by 

the Administration and Congress for an employment subsidybusiness tax cut, the available estimation methods are not 

sensitive enough to measure the ability--let alone clear 

cut differences in the ability--of the alternative policies 

to alter unemployment or the price level in the short run. 

This point deserves emphasis because frequently the justification for a tax subsidy of this magnitude will rely 

heavily on such estimates. In our judgment, there is 

little to choose between a general employment tax credit 

and a public works or public service jobs program, based 

on the simulated impact on unemployment and inflation. 

However. the potential comparative advantages of an 

employment tax credit might appear in a program substantially larger than $2.4 billion. An employment tax 

credit is potentially a stronger inducement to private 

sector employment than is a general tax cut of equal 

budget cost. Also, to the extent that businesses pass on 

lower costs by lowering prices to consumers and if 

expectations of further inflation are thereby reduced, an 

employment tax credit may be accompanied by inflation 

rates which are lower than those accompanying other modes 

of fiscal stimulus. But whether these advantages would 

in fact be realized a question that cannot be answered 

at present. 

If an employment tax credit costing $10 billion to 

$15 billion should be seriously considered in the future, 

comparative simulations at this level would be of 

interest. The outcome of such comparisons would depend 

on the same sorts of assumptions that underl the 

simulations reported here. These assumptions can be 

divided into three broad categories: (1) those relating 

to the level and timing of the spend-out patterns; 

32 
(2) those relating to the response of the policy 

recipients; and (3) those determining the magnitude of 

the impact. 2/ 

In general, one would have more confidence in making 

assumptions related to traditional fiscal policies than 

in making assumptions related to employment tax credits. 

The process through which traditional policies operate 

are--on the basis of experience--somewhat better understood. Little is known, however, about whether employers 

and employees will respond to enable the tax credit to 

realize its potential advantages over competing policies. 

Admittedly, there are uncertainties about whether 

other fiscal policies will work as intended. For 

example, fiscal sUbstitution 3/ may occur in public 

service employment programs, or individuals may save 

rather than spend a large part of a tax rebate. Such 

responses will reduce the stimulative fect of these 

policies. 

Nevertheless, an employment tax credit a higher 

risk policy. Because it is new, there is no direct 

evidence about its performance. Furthermore, if 

employers do not respond as intended, very litt stimulus 

results from an employment tax credit--substantially less 

than from a permanent cut in individual income taxes for 

examp 

THE JOBS TAX CREDIT IN THE TAX REDUCTION AND SIMPLIFICATION 

ACT OF 1977--H.R. 3477 

Because the Jobs Tax Credit is designed to operate 

marginally, with ceilings on both the amount of credit per 

~/ More information on these matters is found in ShortRun Measures to Stimulate the Economy, CBO Staff 

Working Paper, March 1977. 

3 Substituting federal funds for funds that otherwise 

would have been provided by other sources. 

33 
employee and per firm, it is not possible to use either 

the CBO Multipliers Model or any of the commercial largescale econometric models to estimate the employment 

effect of the proposed credit. However, based on the 

fragmentary evidence that is available, and making a 

range of assumptions about employer response to the 

subsidy, a rough guide is that at the uppermost end of 

the estimate, the House version of the Jobs Tax Credit 

would probably yield a slightly larger reduction in 

unemployment by 78:4 than would the Administration's 

employment tax creait. Under the Senate Finance 

Committee version, more employment would be subject to 

the incentive, but the incentive itself would be reduced 

and, on balance, the direct employment effect of the 

credit would tend to be lower than the House version. if 

if Removal of the cap would make an additional onethird of employment subject to the incentive. But 

reducing the wage deduction by the amount of the 

credit would reduce the incentive by about one-third, 

and reducing the credit rate from 40 percent to 25 

percent is another 37 percent reduction in the credit 

rate (.40 - .25 = .15, and .15 is 37.5 percent of 

.40) . 

34 
APPENDIX A 

(TO CHAPTER II) 

ECONOMIC SIDE EFFECTS OF 

EMPLOYMENT SUBSIDIES 

In addition to the intended effects discussed in the 

text, an employment subsidy--as any subsidy--may have 

several unintended economic side effects. 

First, an employment subsidy may encourage firms to 

use what otherwise would be inefficient combinations of 

capital equipment and labor and uneconomic hiring patterns 

and production methods. If operations were being carried 

out at least cost without the subsidy, a change to more 

labor-intensive methods may be inefficient for the economy 

as a whole. Inefficiency raises the true economic cost 

of production and offsets some or all of the benefits of 

an employment subsidy. This is more likely to occur with 

a permanent subsidy. A temporary subsidy is obviously 

worth less to a business than a permanent one of the same 

size and therefore will induce fewer changes in company 

operations and thus have a smaller employment impact. 

Second, the subsidy must be financed either by 

increased taxes or federal debt. Higher taxes involve 

lower disposable income; a greater debt implies greater 

future taxes and, often, higher interest rates. Both 

may reduce the supply of labor and investment in new 

capital. 

Third, the adoption of a temporary or variable 

employment subsidy may cause business managers to 

expect subsidies in the future. Because business may 

become reluctant to hire in advance of the enactment of 

or increase in an expected employment subsidy, the 

adoption of an employment subsidy may be required in a 

future recession. 

Fourth, termination of an existing employment subsidy would be difficult. Businesses would argue that 

removal of the employment subsidy would require them to 

discharge some workers. This argument was made, for 

example, in hearings on the Tax Reform Act of 1976 by 

many proponents of DISC--a tax expenditure that subsidizes 

exports. 

35 
Fifth, a large temporary or variable subsidy might 

induce employers to accelerate production schedules and 

hiring plans. As a result, production would be 

temporarily greater than otherwise, and business inventories could become overly large. Should inventory 

excesses occur, a slowdown in production and employment 

might develop after the employment subsidy expires as 

businesses allow inventories to decline to desired levels, 

thus aggravating rather than smoothing out the ups and 

downs in business activity. 

Finally, the subsidy may be viewed as inequitable 

by those who gain no advantage from it. Although this 

may be more a political than an economic effect, it may 

have economic consequences. 

36 
APPENDIX B-1 

(TO CHAPTER III) 

EMPLOYMENT SUBSIDY LEGISLATION 

IN THE 95th CONGRESS 

At least fourteen employment tax credit bills have 

been introduced in the present Congress; many of these 

were also introduced in the 94th Congress. While employment subsidies are said to be job-creating instruments, 

sponsors of these tax credit bills have a broad range of 

opinions about their roles in reducing unemployment and 

inflation. Some designers of the legislation view employment credit programs as an alternative to increased 

public employment while others view them as just one 

component of a larger employment-inducing program. These 

differing views determine, in part, the characteristics 

of each bill. In this section some of the more common 

issues raised in the bills are described. They are displayed in Table 1. 

Each employment subsidy bill pending in the 95th 

Congress is a marginal tax credit. 

The bills presented in the last session contained 

provisions which denied the credit if new workers merely 

displaced old workers. Not all of the current proposals 

have such safeguards, and even those having such a provision are not specific about how it would be enforced. 

Most of the bills limit either (1) the number of 

employees for whom a firm may receive credit (7 bills) 

or (2) the amount of tax saving with which a firm may be 

credited (4 bills). 

Several bills specify that only certain kinds of 

individuals may earn the credit. For example, a 

worker's employment record before and/or after the 

employee hired may be relevant to the allowance of 

the credit. 

Several bills o~fer subsidies to firms for hiring 

the handicapped and other groups of individuals that are 

traditionally hard to employ. Other bills deny the 

credit for certain individuals, such as those already 

37 
receiving benefits under other government wage subsidy 

and training programs. 

More than half of the bills have carryforward and 

carryback provisions that allow employers to apply the 

tax credit to prior or future years. For bills that 

limit the amount of credit to a firm's yearly tax 

liability (nonrefundable credits), the carryforward and 

carryback provisions increase the value of the credit. 

In addition, three of the bills include recapture provisions that require firms to refund their credit to the 

Treasury if new employees for whom the credit is taken 

do not work the amount of time stipulated in the bill. 

Only one of the bills (Congressman Conable's 

H.R. 2402) specifically provides a subsidy for part-time 

labor. This bill may have different effects than the 

other bills on the labor market and the composition of 

employment. Providing an incentive for hiring part-time 

labor may encourage the hiring of women, teenagers, and 

the aged. On the other hand, the other bills provide 

an incentive for full-time labor and may discourage the 

hiring of these groups. 

Several bills (S. 616, authored by Senator Dole; 

H.R. 121, Congressman Sarasin; and H.R. 297, Congressman 

Conte) stipulate that the amount of the credit depends 

on the unemployment rate in regions in which firms are 

situated. These bills would require close coordination 

between federal and regional administrators and applicants 

for the subsidy. 

The job and cost estimates shown in Table 1 are 

subject to the following comments: 

o Except for the estimate for 

Congressman Derrick's H.R. 2691, 

the estimates were supplied by 

sponsors; 

o Estimates have not been made for all 

the bills, and the available estimates do not make clear whether they 

are limited to jobs that would be 

induced by the bill; 

38 
o There is a large variance in the 

estimates of the number of new jobs 

created and costs of the subsidies; 

o The job and cost estimates are 

unclear about whether they are 

short- or long-run estimates or 

whether the cost estimates take 

into account secondary effects; and 

o In all probability, these estimates 

were not made with consistent 

assumptions and techniques. 

39 
~ 

o 

APPENDIX TABLE 1. EMPLOYMENT SUBSIDY LEGISLATION PHESENTED IN THE 95th CONGRESS 

Legislation Type of Credit 

S. 131 

Senator 

Inouye 

S. 149 

Senator 

Bentsen 

Nonrefundable 

eredit equal to 

the total additional expense 

of hiring 

older people. 

Refundable 

eredit of 5% 

of wage eost 

of number of 

employees in 

excess of 

base. This 

base varies 

with the 

national 

unemployment 

rate. 

Limitations 

Employee must 

meet certain requirements to be 

eonsidered older. 

No maximum subsidy 

Specifications 

regarding when 

and how the base 

is measured for 

subsidy purposes. 

Reeapture 

No 

No 

Mechanies 

Carrvforw~rd Adminisor baek tration 

Estimated 

Number of 

.Jobs 

No Treasury None 

Secretary available 

shall preseribe regulations to 

define "older 

person." 

Estimated 

Federal 

Revenue Loss 

None 

available 

No Administered 2 million $3 billion 

by IRS. 

Bureau of 

Labor Statisties 

vide 

ment 

average annual 

gross wage. 

third 
~ 

f-' 

Legislat ion 

S. 616 

Senator 

Dole 

S. 731 

Senator 

Baker 

Type of Credit 

Nonrefundable 

credit of $l/hr. 

for the lesser 

of (a) number of 

new employee hrs. 

or (b) number of 

increased hrs. 

of employment. 

Amount of subsidy is $1. 501 

hr. if new 

employee was 

previously 

unemployed. 

Nonrefundable 

credit against 

wage cost of 

new employees 

equal to 

(a) $l/hr. for 

the first 26 

weeks of employment; 

(b) $0.50/hr. 

for the second 

26 weeks of 

employment for 

the hrs. worked 

by a 

worker. 

Limitations 

Maximum 

per firm 

is 20% of hrs. 

in excess of last 

year's hrs. times 

amount of subsidy. 

(2) Subsidy will 

phase out in 19RO. 

(3) Subsidy does 

not apply when 

national unemployment is below 6%. 

(1) No maximum 

subsidy per firm. 

(2) New employees 

must have been 

unemployed for 

at least 26 

weeks. 

Recapture 

No 

Yes 

Carryforward Adminisor back tration 

Yes 

Yes 

Treasury 

Secretary 

Labor and 

Commerce 

Departments 

will publicize the 

credit 

through 

appropriate 

programs. 

Labor 

Secretary 

will coordinate this 

program with 

CETA prime 

sponsors. 

Estimated 

Number of 

Jobs 

Estimated 

Federal 

Revenue Loss 

Similar to 

estimates 

of S. 731. 

End of 

calendar 

year 1978: 

250-550 

thousand. 

FY 1978: 

$0.4 billion 

FY 1979: 

$1. 9 billion 
~ 

~ 

Legislation 

H. R. 121 

Congressman 

Sarasin 

(Part of 

Job 

Creation 

and Economic 

Growth Act) 

H.R. 297 

Congressman 

Conte 

(Small 

Business 

Growth and 

Job 

Creation 

Act of 

1977) 

Type of Credit 

Non refundab Ie 

credit equal 

to 25% of 

wages of new 

each 

new employee. 

Nonrefundable 

credit of 50% of 

wages of up to 

2 new employees 

plus 50% of 

of up to 

fied as 

disadvantaged. 

(Disadvantaged 

are handicapped, 

minorities, and 

unemployed 

individuals whose 

unemployment insurance has expired.) Pervaries 

from to 50% 

depending on the 

unemployment 

rate of the area, 

Limitations 

Applicabl e only 

in regions with 

10% or more 

unemployment 

rate. 

Maximum credit of 

$20,000 for 2 new 

employees and 

$60,000 for up to 

23 disadvantaged. 

Recapture 

No 

No 

Mechanics 

Carryforward Adminisor back tration 

No 

No 

Bureau of 

Labor Statistics must 

provide regional unemployment 

rates to 

Treasury 

Secretary. 

Treasury 

Secretary 

shall prescribe regulations to 

define "disadvantaged 

worker." 

Estimated 

Number of 

Jobs 

None 

available 

None 

available 

Estimated 

Federal 

Revenue Loss 

FY 1978' 

$0.2 billion 

FY 1979: 

$0.4 billion 

None 

available 
,;::. 

W 

Legislation 

H.R. 905 

Congressman 

Ford 

H.R. 2434 

Congressman 

Hammerschmidt 

II. R. 2402 

Congressman 

Conable 

(Private 

Sector 

Part-Time 

Employment 

Act) 

Type of Credit 

Nonrefundable 

cr:edit "for a 

certain portion" 

of wages 

new employment 

of handicapped 

person. 

Nonrefundable 

credi t equal to 

(a) 20% 

penses of new 

part-time 

whose 

annual salary 

(EAS) is less 

than $14,000 

plus 

(b) 25% of expenses of new 

part-time 

whose 

Limitations 

Credit is limited 

to first 12 months 

of emolovment of 

number of 

part-time 

is the 

1esser of 

(a) 20% of last 

year's employment 

or 

(b) year to year 

increase in 

employees. 

Recapture 

No 

Yes 

Mechanics 

Carryforward Adminisor back tration 

Yes 

Yes 

Treasury 

Department 

required to 

ask proof 

of handicap. 

Treasury 

Secretary 

must determine compliance of taxpayer to 

regulations. 

Estimated 

Number of 

Jobs 

None 

available 

None 

available 

Estimated 

Federal 

Revenue Los 

None 

available 

None 

available 
~ 

~ 

Legislation 

H.R. 2403 

Congressman 

Conable 

H.R. 2404 

Congressman 

Conable 

(Youth 

Apprentice 

Tax Credit 

Act of 

1977) 

Type of Credit 

Nonrefundable 

credit of $l/hr. 

for the lesser 

of 

(a) number of 

new employee 

hrs. or 

(b) number of 

increased hrs. 

of employment. 

Amount to be 

increased to 

$1.50/hr. for 

previously 

unemployed 

workers. 

Nonrefundable 

credit equal to 

20% of apprenticeship for 

CETA certified employers. 

Limi tat ions 

After 1977, 

credit applies 

to wages for 

employment hrs. 

that exceed 

10% of previous 

year's hrs. 

Maximum eligible 

number of apprentices is 5% of 

total work force. 

Apprenticeships 

must meet certain 

requirements. 

Recapture 

No 

Yes 

Mechanics 

Carryforward Adminisor back tration 

Yes Jointly 

administered 

by Treasury 

and Labor 

Departments 

Estimated 

Number of 

Jobs 

None 

available 

No CETA must None 

available 

program in 

2 years. 

Estimated 

Federal 

Revenue Loss 

CY 1977: 

$2.8 billion 

CY 1978: 

$5.6 billion 

$1,000 per 

apprentice 
Estimated Estimated 

Recap- forward Adminis- Number of Federal 

Legislation Type of Credit Limitations ture or back tration Jobs Revenue Loss 

H.R. 2536 Nonrefundable (1) Credit not No Yes Treasury None None 

credit equal to to exceed $25,000 Secretary available available 

20% of employee of tax liability 

(Human training plus 50% of 

Investment expense. additional 

Tax liability, 

Incentive (2) training ~ Act of program must c.n 1977) . fulfill various 

criteria. 

H.R. 2691 Refundable (1) Maximum No No Treasury 294,000 $6.4 billion 

Congressman credit equal credit per firm Secretary 

Derrick to 50% of is equal to shall prothe first $80,000 vide 2 

year's wages annually. evaluations 

of a new (2) Credit to Congress. 

employee. available 

for maximum 

of 10 employees 

per firm. 
~ 

en 

Legis la t ion 

H.R. 3477 

(Tax 

Reduction 

and Simplification 

Act of 

1977) 

(Passed 

by House) 

Type of Credit 

Nonrefundable 

credit 

to 40% 

excess of 

unemployment insurance w 

over 103% 

ment tnsurance 

wages. Percent 

is increased by 

10% in the case 

of a handicapped 

employee. 

Limitations 

(1) Credit 

not exceed ( 

$10,000 per firm 

(excluding 10% 

addttional credit 

for handicapped 

worker) or (b) 

10% of the 

difference between total 

wages and 103% 

of total wages 

of previous 

year; 

(2) Credit 

expires after 

1978. 

Recapture 

No 

Meccanics 

Carryforward Adminisor back tration 

Yes Treasury 

Secretary 

Estimated 

Number of 

Jobs 

None made 

available 

by Ways 

and Means 

Committee. 

Estimated 

Federal 

Revenue Loss 

FY 1977: 

$0.7 btllion 

FY 1978: 

$2.4 billion 

FY 1979: 

$1.7 billion 
~ 

-..J 

Legislation Type of Credit 

H.R. a/ 

Congressman 

Beard 

Nonrefundable 

credit equal 

to 

taxes ( .9%) 

for reemp 

or new 

Limitations 

(1) Maximum of 

7 employees per 

firm. 

(2) New employee 

and reemployed 

must meet 

specific employment conditions. 

(3) No WIN 

part icipants. 

Recapture 

Yes 

Mechanics 

Carryforward Adminisor back tration 

Yes Treasury 

Department 

must report 

annually to 

Congress. 

Estimated 

Number of 

Jobs 

1.2 

million 

Estimated 

Federal 

Revenue Loss 

None 

available 

Notes: This table includes employment subsidy legislation presented in the 95th Congress prior 

to March 2, 1977. 

Estimates for H.R. 2691 (authored by Congressman Derrick) have been made 

all other employment subsidy bills, estimates have been provided by the 

bill's authors, and CBO has not evaluated these estimates. 

For 

of the 

~/ This is Congressman Beard's bill introduced in the 94th Congress. His office indicated that 

he will introduce a similar bill in this Congress. 

APPENDIX B-2 

(TO CHAPTER III) 

THE WIN PROGRAM: A STRUCTURALLYORIENTED PRIVATE SECTOR EMPLOYMENT 

AND TRAINING PROGRAM 

In addition to the structurally-oriented employment 

and training programs that operate almost entirely within 

the public sector, the federal government also supports 

the Work Incentive Program (WIN) which is designed to 

increase the employability and private sector employment 

of welfare recipients by providing training, work 

experience, and employment opportunities. 

Concern that too many employable adults were 

becoming dependent on welfare led to the authorization 

of WIN by Title II of the Social Security Amendments of 

1967. The Revenue Act of 1971 supplemented WIN with a 

tax credit for employers of WIN participants amounting 

to 20 percent of the wages for the first 12 months of 

employment. The employer was also required to continue 

the employment of the participant for 12 months after the 

12 months for which the credit was claimed. If the 

employer did not meet this condition, then the tax credit 

was "recaptured." Also, the maximum credit was $25,000 

plus 50 percent of the tax liability above $25,000. The 

credit can be carried back three years or carried forward 

seven years. Then, in 1975, the Tax Reduction Act 

(P.L. 94-12) authorized a tax credit similar to the WIN 

tax credit for employers of any AFDC recipient regardless 

of WIN participation. This tax credit was available to 

the employer after only 30 days of employment and there 

was no recapture provision if the employee was terminated 

for misconduct, became disabled, or quit. 

The Tax Reform Act of 1976 (P.L. 94-455) further 

amended both the WIN and AFDC tax credits by doubling the 

maximum amount on which the full credit could be 

claimed. I The WIN program is much more complex than 

II The limit was increased from $25,000 to $50,000 plus 

one-half of the tax liability above $50,000. The 

49 
either a training or public service employment program. 

Through its employment ef cts it may reduce AFDC costs 

and increase the annual earnings of participants. Also. 

it may deter some eligible, but employable, adults from 

applying for AFDC benefits. Finally, there may be 

beneficial effects on the children who live in selfsufficient rather than dependent families. 

Costs 

In fiscal year 1976, $308 million was spent on the 

WIN program. The average cost per year of service was 

$11,000, and the average cost per participant was 

$3,900. 2/ Forty-three percent of the total outlays was 

spent on-training, 23 percent on jobs, and 34 percent on 

other activities such as registration, appraisal, 

orientation, employability planning, and placement. These 

latter activities make WIN a relatively more costly program than other employment and training activities. 

Participant Characteristics 

The WIN program reflects the characteristics of the 

AFDC population. In fiscal year 1976, 44 percent of the 

WIN credit will now also be available from the date 

of hiring, if the employee not terminated without 

cause before the 90 days following the first 90 days 

of employment. In addition, termination because of 

a substantial reduction in business has been 

excluded from the actions causing recapture. 

Finally, a limit of 12 months has been placed on the 

tax credit from the wages of anyone employee. 

£/ See Appendix Table 2 for more detail. The cost of 

the WIN tax credit in terms of revenue loss has not 

been included. The cost is minimal and would not 

affect the general conclusions of the analys 

50 
new participants were from minority groups, 17 percent 

were under 22 years old, 73 percent were female, and 

60 percent had less than a high school diploma. 

Since WIN is aimed at employable welfare recipients, 

certain categories of recipients were exempt from mandatory 

participation: ~/ 

o Persons under the age of 16 or 

attending school full-time. 

o Persons too ill or too old, or 

otherwise incapacitated. 

o A mother or other relative needed 

at home to care for a child under 

six years old. 

o Persons needed at home to care for 

ill or incapacitated family members. 

o Persons so remote from a work 

incentive project that effective 

participation is precluded. 

o Mothers in families where the father 

or another adult male relative is in 

the home and has registered. 

A complex administrative framework involving both 

the Departments of Labor and Health, Education and 

Welfare was designed to screen, register, and appraise 

AFDC recipients for WIN. Appendix Table 2 presents 

WIN program data for fiscal year 1976. Only about 26 

percent of AFDC families had WIN registrants, due to the 

high proportion of adults in exempt status. About 74 

3/ Comptroller General of the United States, Substantial 

Improvements Needed in the Work Incentive Program, 

Atlanta, Georgia (Washington, D.C.: U.S. Government 

Printing Office, July 10, 1974), p. 2. 

51 
percent of the registrants were appraised and only 31 

percent of the registrants were employed full time. 

In other words, only 6 percent of the AFDC families had 

adults placed in full-time employment. 

APPENDIX TABLE 2. FISCAL YEAR 1976 WIN PROGRAM DATA 

Category Persons 

AFDC Recipients 

AFDC Families 

WIN Registrations 

WIN Appraisals 

Employment: bl 

FUll-time -

Part-time 

11,289,000 a 

3,565,000 a 

942,250 

674,677 

211,185 

19,680 

a Based on an average of the first ten months in 

fiscal year 1976. 

b Participants employed for at least 30 days. 

Effects 

The evaluation studies on WIN do not t 

definitive conclusions. A recent study found average 

annual earnings gains of roughly $400. However, the 

results of this study may be more uncertain than the 

recent studies of MDTA training. il 

4 Pacific Consultants, The I A 

dinal Evaluation a: 

This may have designed 

a better control group than the recent MDTA studies, 

but its study period before and after training is 

too short. Orley Ashenfelter has demonstrated that 

the duration of time studied can the research 

results. 

the Devel 

See Orley Ashenfelter, Program Report on 

t of the Continuous Information on the 

52 
The effect on AFDC savings is even more difficult to 

calculate. A recent study concluded that there were little 

AFDC savings associated with WIN participation, but that 

the savings incurred were strongly related to training 

plus job placement, rather than the current emphasis on 

job placement. 51 In addition, the authors found some 

decrease in the-AFDC recipient rate after the shift in 

emphasis toward job placement, which is consistent with 

the belief that WIN may deter some individuals from 

applying for AFDC. However, in both cases it is very 

difficult to assign a dollar value to these effects. 

Effects of WIN and Welfare Tax Credits ~I 

Employer response to WIN and welfare tax credits has 

been minimal. Tax credits were provided for only 15 to 

20 percent of the WIN eligibles who became employed. Some 

employers of WIN registrants were probably not eligible 

for credits because they were either nonprofit businesses 

or had no tax liabilities. The welfare tax credit was 

used even less frequently by employers of former welfare 

recipients. 

Even among employers who have used these tax credits, 

more than 50 percent report that the tax cred s were not 

'fl./ 

§j 

Impact of the Manpower Development Act, Technical 

Analysis Paper No. 12A, U.S. Department of Labor, 

October 1973 (processed). 

Ronald G. Ehrenberg and James G. Hewlett, "The Impact 

of the WIN 2 Program on Welfare Costs and Recipients 

Rates," The Journal of Human Resources, Vol. XI, 

No.2, Spring 1976, pp. 219-32. 

John B. Cosgrove, et. al., Interim Report on the 

Study to Assess WINandWelfare Tax Credits 

(Minneapolis, Minnesota: IMPACT, Inc., Institute 

for Manpower Program Analysis, February 15, 1976). 

53 
an important hiring incentive. One survey found that 

27 percent of the employers who used the WIN credit 

found out about its availability after hiring the WIN 

registrants. 

The reasons for the apparently small efficacy of the 

WIN and welfare tax credits are complex and interdependent. 

Most employers reported that their primary goal in hiring 

is to obtain qualified employees, and many reportedly 

doubt the potential quality of ex-welfare recipients. In 

most firms employment/hiring decisions are the responsibility of personnel units while taxes are within the 

domain of accounting departments. This split of responsibilities limits the impact of tax credits in hiring 

decisions. The low level of the WIN tax credit and the 

requirements for long-term employment commitments also 

inhibit the credit's effectiveness. 

54 
APPENDIX C 

(TO CHAPTER IV) 

RESULTS FROM AND CAUTIONS ABOUT SOME 

STUDIES OF EMPLOYMENT SUBSIDIES 

In preparing this report, we examined a number of 

studies on various aspects of employment subsidies. In 

this Appendix we review two studies--one by Daniel 

Hamermesh for the Brookings Institution and another by 

Fethke and Williamson for the Joint Economic Committee--

for those readers who are likely to encounter these 

somewhat more technical discussions in their work. In 

addition, we present some practical observations on the 

usefulness of large-scale econometric models in analyzing 

employment subsidies. 

HAMERMESH'S STUDY 

Daniel Hamermesh has surveyed leading researchers' 

quantitative estimates of the extent to which employers 

respond to reductions in labor costs by hiring additional 

labor. 1/ He recognizes both the substantial variation 

in these estimates and their only rough applicability for 

estimating the effect of employment subsi~ies. He 

examines two marginal employment subsidies, and calculates 

their employment effect and cost assuming that employers 

increase the labor force by either 1 percent, or 

alternatively by 3 percent, when labor costs are reduced 

by 10 percent. 2/ The size of this response is crucial 

to the estimates, and it essential to understand that 

even the most knowledgeab researchers in the field are 

not very confident about what numbers to use in evaluating 

a specific employment subsidy. 

1/ Daniel Hamermesh, "Econometric Studies of Labor Demand 

and Their Application to Policy Analysis," Journal of 

Human Resources, Fall 1976, pp. 507-25. 

2/ Daniel Hamermesh, Indirect Job Creation in the Private 

Sector: Problems and Prospects. unpublished manuscript. 

dated March 1977, prepared for the Brookings Conference 

on Job Creation, April 1977. 

55 
Using a range of 85 to 100 percent of the previous 

year's wage bill (or employment 3 ) as the employment 

base, Hamermesh calculates the e s of a marginal 

employment subsidy for both a 10 percent reduction in 

wage cost as well as a $3 per worker-day subsidy. 

He simulates the effects in 1975 of an 

employment subsidy that was assumed to be put into 

operation in mid-1974, using calendar 1974 as the base 

period. The simulations apply only to private nonfarm 

industry. 4 

The simulation results for the 10 percent wage 

reduction and the $3 per worker-day subsidy are shown 

respectively in Appendix Tables 3 and 4. The top half 

of each table is based on the I percent response parameter 

(that is, an "elasticity!! of O. I) while the bottom half 

uses 3 percent (that is, an elast ity of 0.3). For each 

case, the tables show the number of jobs that were created 

solely as a result of the credit, the total cost of the 

program, the program costs that would go subsidize jobs 

which would have existed anyway ("windfall"), and the 

gross cost of each new job induced by the credit. As compared to the 0.1 elasticity, the 0.3 asticity results 

in more induced jobs and less total cost per induced job. 

The tables also indicate that, whether the elasticity 

is 0.1 or 0.3, as the employment base increased (see 

column 1) the number of jobs induced by the subsidy 

declines (see column 3), as does the cost of the program 

(column 4), the amount of windfall, and the cost per job. 

Thus, the choice of the percentage of the wage base to 

3f The Hamermesh draft is ambiguous about this. 

if The extent to which a firm can take advantage of the 

credit depends on the rate at which it is expanding. 

There considerable variation in rates of expansion 

among firms. Hamermesh disaggregates private nonfarm 

employment into 171 industries and then treats each 

industry as a "firm." This provides a crude approximation to the variation in expansion among firms and 

adds to the realism of the simulation results. 

56 
APPENDIX TABLE 3. IMPACTS OF A TEN PERCENT WAGE SUBSIDY 

------------------~------~~---~~~----

Range subsidized 

(as fraction of 

base year payroll) 

lower U~mit Elasticity 

Jobs created 

(thousands) 

Cost Windfall 

(billions (bill ons 

of doll ars) of doUars) 

-~---~ ---------------------------

0.85 

0.90 

0.95 

1. 00 

0.85 

0.90 

0.95 

1. 00 

0.1 

0.3 

288 

250 

189 

llO 

866 

766 

592 

369 

6.461 6.213 

3.958 3.752 

1.993 1.843 

.651 .580 

6.958 6.213 

4.383 3.752 

2.305 1.843 

.816 .580 

Cost/Job 

... -------

$22,461 

15,816 

10,537 

5,867 

$ 8,039 

5,725 

3,893 

2,210 

... ----~~~ 

Source: 

APPENDIX TABLE 4. IMPACTS OF A $3/DAY WAGE SUBSIDY 

Range subsidized 

(as fraction of 

base year payroll) 

lower limit 

0.85 

0.90 

0.95 

1. 00 

0.85 

0.90 

0.95 

1. 00 

Source: 

Elasticity 

0.1 

0.3 

Jobs created 

(thousands) 

297 

264 

207 

137 

893 

802 

686 

446 

57 

Cost 

(billions 

of dollars) 

5.346 

3.415 

1. 817 

.671 

5.746 

3.773 

2.101 

.816 

WindfaJ 1 

(bill ions 

of dollars) 

5.148 

3.240 

1.679 

.582 

5.118 

3.240 

1. 679 

.582 

Cost/Job 

$18,000 

12,926 

8,794 

4,889 

$ 6,434 

4,706 

3,062 

1,931 
be subsidized is a crucial decision in the design of an 

effective employment tax credit. Because Hamermesh's 

calculations were performed over a period of declining 

employment, they would not provide guidance about that 

choice for a recovering economy. 

Hamermesh compares the cost per job of employment 

subsidies to the estimated costs per job after one year 

of various other stimulative measures, as calculated by 

other researchers. 5/ Even with an assumed elasticity 

Item 

Generalized government purchases 

Tax cut 

(after eight quarters) 

Public service employment (assuming 

55 percent job displacement) 

Cost per 

net job 

$ 18,600 

212,000 

19,700 

14,500 

of 0.1, the cost-per-job figures for a marginal employment subsidy compare favorably with these figures, except 

for the lowest employment base threshold. In his most 

recent statement (letter to Editor of New York Times, 

February 24, 1977), Hamermesh says that careful estimates 

suggest that a tax cut of 10 to 20 percent of wages of 

workers above 90 percent of a firm's previous year's 

employment would produce 60,000 new jobs per billion 

dollars of tax cut. This is about $16,700 of revenue 

cost per job induced. 

Hamermesh's letter does not indicate either the 

details of the employment tax subsidy or the method used 

5 George Johnson and James Tomola, The Efficacy of 

Public Service Employment Programs, unpublished, 

University of Michigan, June 1975. 

58 
in making the estimate. However, the point to be 

emphasized is that the assumption about employer response 

to the subsidy is crucial to such estimates, and that a 

great deal of uncertainty surrounds the assumption of 

even the range of 0.1 to 0.3 used by Hamermesh. The 

cost-per-job estimate he makes in his New York Times 

letter could reflect the assumption of a response 

(elasticity) of even less than 0.1. For some marginal 

employment tax credits with limits on the number of 

eligible employees or the amount of credit per employee 

or per firm, an elasticity of considerably less than 0.1 

would be a reasonable assumption. 

LARGE-SCALE ECONOMETRIC MODEL SIMULATIONS 

Large-scale econometric macroeconomic model 

simulations are sometimes used to estimate the short-run 

impact of an employment subsidy and other fiscal policies. 

The advantages of this approach are twofold: (1) the 

structure of such models makes it possible to observe 

quarter-by-quarter fects that follow the imposition 

of a fiscal policy and (2) the model provides estimates 

of the impact of the policy on a number of economic 

variables, such as the rate of inflation and GNP, rather 

than on employment alone. 

Caution is required in interpreting and using the 

results from large-scale macroeconomic model simulations 

of employment subsidies. All of these models assume 

that aggregate demand determines output and that output 

determines employment; labor and capital costs do not 

directly affect the short-run demand for labor. Therefore, to simulate the effects of an employment subsidy 

on such models, it is necessary first to assume how and 

how much an employment subsidy will raise demand--e her 

by increasing firm profits, wages and salar s, or 

reducing prices and thus increasing real disposable 

income. It is not apparent which of these income components will rise initially as a result of the employment subsidy. The models' simulations, by assuming 

specific responses on the part of employers and workers 

who participate in the employment subsidy. cannot test 

the likelihood of these responses. 

59 
The models have additional limitations for simulating 

employee subsidies. The ability of firms to make substitutions between labor and capital in response to 

changes in wage and interest rates is not incorporated 

into the models' structures. Also those structures lack 

the detail necessary to provide reliable estimates of 

categorical or marginal employment subsidies. Furthermore, 

the models are unable to capture the importance of 

expectations about inflation or other aspects of business 

conditions for policies such as temporary employment subsidies. Finally, wide variations among macroeconomic 

model structures produce a wide range of estimates on the 

effectiveness of employment subsidies, whatever the 

assumptions about the economic behavior responses. 

An additional reason for being cautious about any 

policy simulations on an econometric model is that the 

estimates provided are very sensitive to the initial 

assumptions used to simulate the policy. These assumptions 

can be divided into three broad categories: (1) those 

relating to the level and time of the spend-out patterns, 

(2) those relating to the response of the policy recipients; and (3) those determining the magnitude of the 

impact. Comparing such assumptions across alternative 

policies provides some insight into the relative effectiveness of one policy versus another. 

The faster authorized federal dollars are spent (or 

tax collections reduced) the sooner employment changes 

will occur. The alternatives to an employment tax credit 

vary widely, however, in the speed with which their 

stimulus is attained. With respect to the spending 

options, spending of additional federal budget authority 

is faster to the extent that the programs are already in 

existence. The speed is limited, however, for public 

service employment by the extent to which state and local 

governments can absorb additional job slots, for public 

works programs by the eed with which projects can be 

selected and put into full swing, and for countercyclical 

revenue sharing by the delays induced by state and local 

budgeting procedures. 

Tax options (including employment subsidies) tend 

to place money into the economy more quickly than 

spending options, with the possible exception of public 

60 
service employment, although the machinery to return taxes 

to taxpayers cannot operate instantaneously. The more 

complex is the machinery (for example, that required for 

marginal and categorical employment tax credits), the 

longer will be the time delays. Tax rebates can be 

mounted more rapidly than permanent tax reductions. 

The impact of the stimulus policies also depends on 

target group behavior. As discussed in Chapter II, the 

short-run effects of an employment subsidy depend largely 

on whether a firm uses the subsidy to increase cash flow 

(and, in the case of marginal credits, whether a firm uses 

the subsidy at all) or to lower prices and increase 

employment. The amount of stimulus from personal tax 

changes depends primarily upon the percentage of the 

tax reduction that is saved. Because, as it is commonly 

believed, more of a rebate than a permanent tax reduction 

is saved, a rebate has a lower stimulus per dollar spent 

although its impact comes much faster. Finally, the 

stimulus from federal spending alternatives is reduced 

to the extent that new federal outlays simply replace 

funds that would otherwise have been provided by other 

sources (that is, fiscal substitution). 

Additional factors are relevant in determining the 

impact of alternative fiscal policies. The smaller is 

the cost per job and the larger is the fraction of the 

additional dollars going to wages and salaries, the greater 

is the employment impact of public service employment. 

How states and local governments use countercyclical 

revenue sharing funds and the substituted funds from 

public service employment programs is an important 

determinant of stimulus policy impacts. In the case of 

employment subsidies, the responses of the labor force 

influence the subsidy's stimulus: if workers bid-up 

wages as a result of the subsidy, the policy becomes comparable to an income tax cut. Furthermore, should prices 

fall as a result of the subsidy, the extent to which the 

price level change affects inflationary expectations will 

influence the net stimulus provided by this policy. 

Simulations of fiscal policies are sensitive to 

assumptions such as those outlined above. Small changes 

in assumptions can alter both the absolute and relative 

efficiency of any proposed stimulus option. 

61 
FETHKE AND WILLIAMSON STUDY 

A recent paper 6/ prepared for the Joint Economic 

Committee by Professors Gary Fethke and Samuel Williamson 

examines the effects of a variable-base marginal employment subsidy. This credit is intended to be a fiscal 

policy stabilization tool and is expected to be effective 

only when stimulus is desired. It is not its purpose to 

have a long-run effect on capital-labor ratios or on 

economic growth rates. The effect of the subsidy is 

simulated using a simplified macroeconomic model of the 

United States economy in which all responses occur 

instantaneously rather than with real-life delays as we 

discussed above in Chapter II. 

Fethke and Williamson conclude ,that employment would 

be increased by their credit whether the federal budget 

deficit .is increased or held constant by either an 

increase in other taxes or a decrease in expenditure. If 

only incremental employment is qualified for the credit, 

a I percent wage subsidy would: increase employment by 

0.9 percent, increase real GNP by 0.5 percent, reduce 

consumer prices by 0.5 percent, raise real wages by 0.6 

percent, while leaving the budget deficit unchanged or 

slightly lower when the simulation is run using fourth 

quarter 1975 levels of economic variables. To the extent 

that the credit is extended to more than incremental 

employment, the employment effect increases only to the 

extent that the deficit increases. 

The analysis presented above in Chapter II would 

suggest that the results of the Fethke-Williamson study 

are overly optimistic. Although ingenious, their model 

neither portrays cyclical economic conditions nor looks 

at the short-run path of adjustment to a subsidy. Rather 

it provides a theoretical picture of the economy after 

all adjustments have occurred. Thus, while the authors 

purport to analyze the subsidy as a "short-term supplement to existing fiscal and monetary policy tools," they 

6/ Gary Fethke and Samuel Williamson, Employment Tax 

Credits as a Fiscal Policy Tool, prepared for the 

Joint Economic Committee, 1976. 

62 
do so with an economic model which assumes specific 

economic responses which are unrealistic for the short 

run. The results of their experiment merely illustrate 

the possible effects of an idealized marginal credit--

one which subsid s only employment that otherwise would 

not occur and induces-an-immediate response from employers 

who will simultaneously hire additional workers, reduce 

their prices, and sell their increased production. 

In real life) cyclical activity produces conditions 

in which such responses are less likely. To be sure, 

the authors provide the reader with caveats about their 

results, and their analysis deserves praise; but still 

there are some cautions that deserve mention here. 

Specifically, the authors' assumption about employer 

responsiveness to the subsidy falls in the high range of 

recent research estimates and should be reduced to 

account for slack demand in recession periods, mismatches 

between unemployed workers and types of workers the firm 

demands, and for the uncertainty attached to a variablebase subsidy. Furthermore, their highly aggregated 

econometric model of the economy does not account for 

differences between labor markets and among employers 

operating in these markets. It therefore overstates 

the number of jobs induced by the subsidy, underestimates 

the amount of windfall, and thus understates the revenue 

loss per job induced. 

The Fethke-Williamson results may not be reliable 

medium-run estimates either. The temporary nature of 

the variable-base marginal employment subsidy may produce 

medium-term responses which are less than those presumed 

by Fethke and Williamson. 

63 

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