In Baltimore this morning, President Obama announced his proposal for a job creation tax credit for small business, which would spend $33 billion dollars trying to encourage hiring in the small business sector, where a majority of all job creation originates. This is combined with the $30 billion proposal for community banks to lend to small businesses, adding up to a serious commitment to the small business sector.

The White House describes their proposal like this:

• Businesses will receive a $5,000 tax credit for every net new employee that they employ in 2010. The total amount of credit will be capped at $500,000 per firm, to ensure that the majority of the benefit goes to small businesses.

• Small businesses will be reimbursed for the Social Security payroll taxes they pay on
real increases in their payrolls. Specifically, firms that increase wages, expand hours or
hire new workers would get a credit against the added payroll taxes that result. This bonus would be based on Social Security payrolls, so it would not apply to wage increases above the current taxable maximum of $106,800.

• Firms will be able to claim the credit on a quarterly basis, which gets money out to
businesses quickly and provides an early incentive to hire and increase payrolls. Non-
profits will be eligible for the credit and start-ups will be eligible for half the credit.

• The proposal is estimated to cost $33 billion.

It’s worth wondering whether this is a commitment to small business or something of a giveaway. While the CBO has gauged this to be an effective technique at stimulating job creation, others have wondered whether this would allow small businesses to take a subsidy for people they were already planning to hire. Economists at the Center for Budget and Policy Priorities expressed tepid support for this kind of measure, but worried about the design.

Tax cuts targeted on job creation have some advantages compared with general business tax cuts but there are serious practical difficulties in designing such measures and their net impact on job creation is uncertain. How would one identify which jobs in expanding firms were created due to a jobs tax credit and which would have been created anyway? How would one identify jobs in contracting firms that would have been lost without the credit? The temptation for firms to game the system would be huge. Proposals that take these concerns seriously acknowledge that the large majority of jobs that receive such a tax credit would have been created anyway.[4] That means that a large percentage of the money spent is a business windfall that generates little new demand, as described above.

Econometric evidence suggests that even if they experience no increase in demand for their products, some firms will respond to such a tax credit by expanding employment. The wages supported by the credit will represent a net increase in demand, and the jobs will represent a net increase in employment. In terms of bang-for-the-buck, however, there is a real question whether a targeted jobs credit is as effective as the UI/food stamp/state fiscal relief measures discussed above.

For their part, the Administration says that they would look at net increase, not grass hiring, and would deny the credit to businesses which switch from full-time to part-time workers, which they say would cut down on gaming the system. Obama acknowledged that there would be some gaming in his remarks today:

Now, it’s true that in some instances this tax credit will go to businesses that were going to hire folks anyway. But then, it simply becomes a tax cut for small businesses that will spur investment and expansion. And that’s a good thing, too. And that’s why this type of tax cut is considered by economists — who rarely agree on anything — to be one of the most cost-effective ways of accelerating job growth, especially because we will include provisions to prevent people from gaming the system. So, for example, you won’t get a tax credit for doubling your workforce while cutting the hours of each worker in half. We’re not going to let you game the system to take advantage of the tax credit, unless you’re doing right by your workers.

Obama stressed that this tax credit is merely a part of the jobs bill that he hopes will pass the Senate in the coming weeks, but the Senate is grinding down the size of the bill so much that the $33 billion earmarked for this approach would result in much of the overall size. Tom Harkin is fighting to keep the cost higher than the $80 billion floated earlier this week. He also rejected this manner of job creation tax credit:

Sen. Tom Harkin (D-Iowa), chairman of Health, Education, Labor and Pensions (HELP) Committee, said he wants the package to exceed $80 billion and he has panned a proposal to give tax credits to businesses that hire new employees.

“I think it’s going to have to be a bigger package than that,” said Harkin.

Harkin said Senate Democrats met with economists who have told them “$80 billion won’t make a difference.” [...]

Senate Finance Committee Chairman Max Baucus (D-Mont.) is pushing tax cuts for small businesses and Senate Majority Whip Dick Durbin (D-Ill.) said the tax credit for new hires is still on the table.

Harkin said he “totally disagreed” with estimates that small-business tax credits would spur significant job growth.

“If you give a small business a tax break for hiring someone that is unemployed, how do you know they wouldn’t have hired that person anyway?” Harkin said.

Furthermore, if this package needs to follow the recent paygo rules and have offsets, it will do nothing for aggregate demand and barely be worth the effort.

Stay tuned…