Temporary Tax Relief to Create Jobs and Jumpstart Growth
The president proposes a number of tax provisions designed to encourage firms to expand and hire more workers. The three largest of those proposals would extend the temporary 100-percent first-year deduction for the full cost of certain property, provide a temporary 10 percent tax credit for new jobs and wage increases, and increase tax credits for energy-efficient investments.
Extend 100-percent first-year depreciation deduction for certain property
To determine taxable income, businesses subtract expenses from their receipts. While some business expenses are for items that are entirely used up during the year (e.g., materials and labor), other business expenses are for durable goods that last for many years. When durable goods are purchased, businesses do not incur an immediate cost, but instead exchange one asset (cash) for another (capital assets). The expense for investment in capital assets (e.g., tractors, computers and wind turbines) occurs over many years as the value of the investment is used up or depreciated. Under current law, businesses calculate taxable income by deducting capital costs over time according to fixed depreciation schedules.
Over the past decade, Congress has repeatedly allowed faster depreciation of certain capital assets to stimulate investment by providing a “bonus” depreciation allowance for qualifying assets in the year the asset was purchased. In 2002, Congress let businesses claim a “bonus” depreciation allowance equal to 30 percent of the cost of qualifying assets purchased between September 10, 2001, and September 11, 2002. The following year, Congress raised the deduction to 50 percent of these investments purchased after May 5, 2003, and before January 1, 2005. The 2008 economic stimulus package renewed the 50 percent deduction again, this time for investments made during 2008. The American Recovery and Reinvestment Act of 2009 renewed the 50 percent deduction for investments made during 2009.
The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, enacted in December 2010, allowed business taxpayers to claim 100 percent bonus depreciation for qualifying investments placed in service between September 8, 2010 and December 31, 2011 and extended 50 percent bonus depreciation through the end of 2012. The Administration proposes to extend the temporary 100 percent bonus depreciation enacted for 2011 through the end of 2012, enhancing what would have been 50 percent bonus depreciation.
Not all property qualifies for bonus depreciation. Qualified investments include tangible property with a recovery period of 20 years or less, water utility property, certain computer software, and qualified leasehold improvement property. Furthermore, only new property qualifies for bonus depreciation.
Accelerating depreciation deductions does not increase the total amount a company can write off for a given investment. Instead, it allows businesses to deduct more of the cost now and less in the future. That reduces their current tax liabilities at the cost of higher taxes later. Since deductions today are worth more to taxable businesses than deductions in the future, the provision lowers the effective tax rate on new investment, thus making investment more attractive. Allowing a full immediate write-off reduces the effective tax rate on new investments to zero because the pretax return on the investment will be exactly equal to the after-tax return. In effect the government becomes a partner in the investment. At a 35 percent corporate income tax rate, the government effectively incurs 35 percent of the investment costs (through the tax deduction), but then later recaptures 35 percent of the returns in higher tax revenue. Lower taxes also increase business cash flow in the short term, so in addition to the incentive effect it helps cash-constrained companies raise funds.
Economic research suggests that bonus depreciation enacted in 2002 and 2003 had relatively modest effects. There are at least three reasons why. First, businesses may have expected that Congress would extend the provisions, thus blunting their incentive to speed up investment. (Such expectations would have proven correct.) Second, it takes time for businesses to make major investments, making it hard to fit them into specified time periods. Third, many businesses may have had too little income to offset with these additional tax benefits, a problem that is especially acute during economic downturns. As the economy recovers and business profitability increases, however, the incentive effect of faster write-offs also increases. But at today’s low interest rates, the ability to claim deductions sooner may have less value than they will have in subsequent years when, according to both Administration and CBO projections, interest rates will be higher.
The revenue loss of the provision is front-loaded, occurring entirely within fiscal years 2012 and 2013. Bonus depreciation decreases tax payments in the year when firms claim it, but increases payments in future years (relative to current law) when firms could no longer deduct the cost of their 2012 investments. The administration estimates that the provision would lose revenue in fiscal years 2012 and 2013 and then raise revenue in every subsequent year through 2022. Revenues would fall by an estimated $35 billion in fiscal year 2012 but then increase by $31 billion during the 2013-2022 budget window, for a net revenue cost of $4 billion over the 11-year period. The present value of the cost is larger than the sum of the revenue changes if a positive discount rate is applied to future revenue flows. For example, at a 3 percent discount rate, the present value of the revenue loss through 2012 is about $8.7 billion.
Provide a Temporary 10 Percent Tax Credit for New Jobs and Wage Increases
The Administration proposes a temporary jobs credit for companies that pay more wages in 2012 than in 2011, whether because of new hires or increased wages per employee. The credit would equal 10 percent of the increase in the employer’s eligible wages between 2011 and 2012. The proposal would cost $14.2 billion in fiscal year 2012 and another $18.4 billion between 2013 and 2022, for a total cost of $32.7 billion between 2012 and 2022. Most of that cost ($26.8 billion) would occur in fiscal years 2012 and 2013.
The credit would apply to no more than $5 million of the increase in a firm’s qualifying wages and would therefore limit the credit to $500,000 per firm and thus focus benefits on smaller firms. In addition, the credit would apply only to wages subject to Old Age Survivors and Disability Insurance (OASDI) tax, which are capped at per employee of $110,100 in 2012. As a result, the credit would not apply to most earnings of the highest earners. For employers with no OASDI wages in 2011, the base wage for determining their increase in wages would be 80 percent of their OASDI wage base in 2012. The credit would be treated as a general business credit. A similar credit would be available for qualified tax-exempt employers.
The proposal aims to accelerate the growth in employment as the economy continues to recover from the deepest economic slump since the great depression and to help small businesses. The main way to increase jobs is to raise demand for goods and services, thereby spurring employers to hire new workers or expand hours of current employees to meet the demand. But in addition to raising demand, the credit would also reduce the cost of labor in 2012, encouraging some firms either to hire more workers permanently or to accelerate hiring into 2012.
Injecting $27 billion into the economy through this additional tax cut for businesses would provide a modest increase in aggregate demand, but its effectiveness in raising demand depends on how quickly beneficiaries spend the tax cut. That, in turn, depends on who benefits from the tax cut. To the extent the credit would go to business owners who would increase employment without the credit, it would simply raise profits. Only new hires or wage increases that would not otherwise have occurred would benefit workers. Because workers generally have lower incomes than business owners, they are likely to spend—rather than save—a higher share of any additional income. The credit would therefore increase demand more if it spurs new employment growth or wage increases rather than rewarding growth in employment and wages that would otherwise occurred. Higher business profits could, however, raise investments by firms who lack access to affordable credit, but these firms are unlikely to invest more unless there is demand for their products.
Reducing the cost of hiring workers could also raise employment if the lower net wage cost enables firms to reduce their prices and sell more or if it encourages them to substitute labor for capital in production. The effect of the subsidy on labor cost would be fairly modest, however. Recruiting and training costs for new workers are generally high relative to their productivity in the first year on the job, so a one-year subsidy for new workers would be a much smaller share of first-year labor costs than its share of the worker’s compensation. Employers typically recover these initial costs if they retain employees longer than one year, but the wage subsidy in the proposal would cease after 2012 and not lower future labor costs. And if firms react to the subsidy by raising wages of existing employees instead of hiring new workers, there may initially be little net new job creation. (Nonetheless, tying the subsidy to total wages instead of employment does prevent the abuse that might occur if firms react to a “new jobs” subsidy by substituting part-time for full time employees.)
The purpose of making the credit incremental instead of providing a flat rate subsidy, such as a temporary payroll tax credit for all firms, is to raise the share of credits that provide an incentive for increases in employment and wages relative to credits that go to “baseline” wages that would have been paid without an incentive. By reducing subsidies to baseline wages, an incremental credit in theory raises the “bang for the buck” – that is, the amount of additional payroll per dollar of government budgetary cost. But it is impossible to determine what firms would have been done without the credit. An incremental credit fails to provide an incentive for firms with falling demand to reduce their employment less quickly and provides benefits for firms experiencing rising demand that would hire more workers even with no tax incentive. Moreover, an incremental credit would have arbitrary and capricious distributional effects, rewarding firms and workers in expanding industries and regions of the country while failing to help those industries and firms still experiencing economic stagnation.
Limiting the credit to $500,000 per firm effectively limits most of the benefits and all of the incremental incentive to small firms. Other firms and their employees would benefit also, however, to the extent the credit raises aggregate demand and employment through increased spending by those newly employed and business owners with increased profits. But the limit would reduce the cost-effectiveness of the credit, because all firms otherwise increasing payroll by more than $5 million would receive the full maximum credit without any incentive to hire more workers.
Making the credit available only for 2012 increases in jobs could encourage some firms to hire workers late in 2012 who they otherwise would have hired in 2013. The acceleration of jobs would not directly increase employment in 2013 and beyond, but could indirectly raise jobs in 2013 if the new hires help accelerate the economic recovery by spending some of their increased wages.
The last experience the United States had with a credit for incremental employment was with the “new jobs credit” enacted at the beginning of the Carter Administration in 1977. Evaluations of that credit and how it came about found that most firms were either unaware of the credit or did not respond to it. Research based on a Department of Labor survey found that only 6 percent of firms who knew about the credit said that it prompted them to hire more workers. Firms that were aware of the credit, however, increased employment about 3 percent more than other firms. This may reflect a positive incentive effect or that firms who were planning to hire additional workers were more likely to find out about the credit.
Some economists view the 1977 experience favorably and believe an incremental refundable jobs credit that corrects some of the flaws of the 1977 law could be very a cost-effective way of creating new jobs. These analysts, however, criticize the cap on each firm’s increased payroll in the 1977 legislation, which is also a feature of the current proposal.
In summary, the effect of this proposal on employment is very uncertain. In theory, an incremental jobs credit could be a cost-effective way of raising employment in the short run and some research suggests that the 1977 credit did increase jobs, although the evidence on that is far from conclusive. The effectiveness of any jobs subsidy depends greatly on both the details of the proposal, still to be finalized, and on how employers perceive its potential benefits when making hiring decisions.
Increase Tax Credits for Energy-Efficient Investments
Current law contains numerous incentives to promote investments in conservation, renewable energy and energy-saving technologies by individuals and households. Many of these incentives are temporary. The president would extend through calendar year 2012 a number of provisions scheduled to expire at the end of 2011.
The president also proposes two expansions of existing tax incentives. One proposal would raise the budgetary ceiling on tax credits for investments in qualified advanced energy projects by $5 billion over a two-year period after the date of enactment of the proposal. In general, eligible projects include those that expand facilities to generate energy from renewable resources, produce or facilitate use of electric or hybrid vehicles, support transmission and storage of renewable energy, capture and sequester carbon dioxide emissions, refine or blend renewable fuels, produce energy conservation technologies, or in other ways reduce greenhouse gas emissions. The current cap on the credits is $2.3 billion. Because the credit equals 30 percent of amounts invested, the additional $5 billion in credits would support almost $17 billion in additional qualifying investments. The Obama administration notes that many technically acceptable projects have not been funded because of the current limitation and that lifting the ceiling would allow quick deployment of new investments. The higher ceiling on tax credits would reduce revenues by $3.5 billion between fiscal years 2013 and 2022 and another $0.2 billion in fiscal year 2012. A similar proposal was included in the fiscal 2012 budget.
The president also repeats a proposal from the 2012 budget to replace the existing tax deduction for energy-efficient commercial building property expenditures with a tax credit that would offset 100 percent of creditable expenditures for property placed in service in calendar year 2013. The amount of creditable expenditures for any property would be limited based on the square footage of the property and the extent to which the investment reduces annual energy and power costs. The provision would cost about $1.7 billion through fiscal year 2022.
By reducing consumption of fossil fuels, the projects these proposals would subsidize might reduce greenhouse gas emissions that contribute to global warming, reduce U.S. dependence on insecure world oil markets, and accelerate the development of new technologies that might ultimately be viable without government subsidies. A more direct and efficient way to achieve these goals is to raise the price of greenhouse gas emissions, either by imposing an excise tax on CO2 emissions or establishing emissions limits with tradable permits (“cap and trade”), but such a direct approach is not currently politically feasible. As an alternative, subsidies to conservation and renewable energy technologies could generate net economic benefits if the investments they subsidize would be economically viable at prices that reflect the full social costs of consuming fossil fuels. The disadvantage of using subsidies is that government is not necessarily good at picking the winners among competing technologies. In addition, because many of the current tax incentives are scheduled to expire with a short time period, they may not be effective in stimulating projects with a long time horizon.