Well-designed employer tax credits can encourage significant job creation, and at an affordable cost per job. But the devil is in the details. The employer tax credit in the Senate’s “jobs bill” is likely to create few jobs, and at an excessively high cost.

The Senate’s employer tax credit is based on a design proposed by Senators Chuck Schumer and Orrin Hatch.  The Schumer-Hatch proposal has several questionable design details: (1) credits are awarded for hires, not net job creation by employers; (2) the credits are limited to hires of persons unemployed at least 60 days; (3) the credit rate is only 6.2% for the rest of 2010; and (4) there is a modest retention bonus of $1,000 per new hire retained for a year, but little up-front cash to encourage job creation.

Awarding credits for hires can be very expensive. Over a one-year period, the number of hires, as a percentage of total private employment, is over 40% even during a recession. To pay for hires that would have occurred anyway will be expensive and won’t necessarily increase total private-sector employment. The Schumer-Hatch design tries to avoid some of these large costs in several ways. First, credits are limited to hiring the unemployed, apply only to the rest of 2010, and are only worth 6.2% of the new hire’s payroll costs. The retention bonus is of modest size and is delayed.  While these limits control costs, they also hamper the credit’s benefits.

Limiting the credit to hiring someone unemployed at least 60 days makes the credit less attractive to employers. Not only does the credit become more complicated to claim (which reduces its effectiveness), But it restricts the employer’s hiring to a more limited pool of workers.

Past experiences (for example, with the Targeted Jobs Tax Credit, the Work Opportunities Tax Credit, and the Welfare-to-Work Tax Credit) suggest that tax credits to encourage employers to hire disadvantaged workers usually elicit little employer interest, and have little effect upon employer behavior. Employers are happy to claim such credits if they happen to meet the credit’s rules, but they are reluctant to change their behavior in response to such targeted tax credits.

Targeting particular groups of the unemployed is more effectively done through the workforce training system. This research comes from on-the-job training subsidies in federal workforce programs and welfare programs, and various local experiments, such as the MEED program in Minnesota.  Local offices can recruit employer interest in such programs, match employers with disadvantaged workers who are suitable, and provide supports to increase job retention. Local offices can also monitor such programs to make sure that the subsidies do affect hiring decisions, and are being used to create permanent jobs for the unemployed.

Limiting the credit to 6.2% for the rest of 2010 also limits the credit’s effectiveness at creating new jobs. For many employers, such a limited credit will be too small to change employer hiring behavior. For example, if an employer is not in a position to even consider expansion until the last quarter of 2010, it is difficult to believe that a 6.2% hiring credit for the final three months of the year will have much effect on their decision about how many hires to make.

The $1,000 bonus for one-year retention of qualified hires provides only a modest incentive for hiring and retaining workers. However, the lack of upfront incentives reduces the Schumer-Hatch bill’s effectiveness. More upfront incentives may be more effective with small businesses, as small business job creation may be inhibited by cash-flow concerns.

John Bishop and I estimate that the Schumer-Hatch proposal will create no more than 200,000 jobs, even assuming that its administrative complexity doesn’t discourage employers from claiming the credit.

Are there alternative employer tax credits to the Schumer-Hatch approach that would be more effective in creating jobs? Yes, there are a number of good alternatives, including the proposal made by President Obama, proposals made by Senators Robert Casey and Russ Feingold, and Congressman Bob Etheridge, and finally the proposal that we developed for EPI. These better proposals have the following features:

* They provide incentives that are tied to whether the employer expands employment and payroll, not simply on whether the employer is hiring. Net employment and payroll expansion is what we want to reward, not simply hiring and keeping the number of employees the same.

* They focus simply on employment and payroll expansion, not who is hired, which is more complicated to administer and monitor and reduces employer interest in a tax credit.

* They are large enough that it is more plausible that the credit will significantly change employer behavior, rather than simply being claimed for a hire that would have been undertaken anyway.

* They provide sufficient immediate assistance that the credit can boost job creation with those employers concerned about cash-flow.

In addition, if the Congress wishes to target the employment of disadvantaged workers, which is a worthy goal, this can be done more effectively by funding subsidized employment through the workforce and/or welfare system. Senator Al Franken has a bill that would federally fund a version of the MEED program, which provided subsidized employment experiences for unemployed Minnesotans during the 1980s. There also are some recent state experiments with subsidized employment experience that have been funded with stimulus dollars. Continued and expanded funding of such programs would help create jobs for many unemployed workers.

The Schumer-Hatch approach may modestly boost job growth, and symbolize Washington’s concern over the plight of the unemployed. But we need to go beyond symbolism. If we want to effectively encourage job growth through a tax credit, we need a program that tightly targets that goal with a large enough credit to significantly affect employer’s hiring decisions. And if we want to effectively target who gets hired, we need to run such efforts through the workforce system, which can perform the required matching, monitoring, and support.

(The author is a senior economist with W.E. Upjohn Institute)