Let's Talk Stimulation...

Well, we're starting to get some of the specifics of President-elect Obama's plan for stimulating us back into the '90s, and given that it has already upset Paul Krugman, I suspect parts of it actually make some sense. What I'm interested in is the two initiatives making up the bulk of Obama's proposed tax cuts. The first is the $3,000 tax credit to companies for every job created. The second is the liberalization of tax-loss carrybacks.

The $3,000 Tax Credit For Jobs Created

Critics are already pointing out that this sort of scheme will be difficult and expensive to administer as well as vulnerable to fraud and abuse. It is difficult to argue with that. What I haven't seen anyone mention that a $3,000 tax credit simply isn't enough of a credit to provide a real incentive for companies to seriously consider hiring new employees. Think of it this way:

The Peasant Accounting Corporation, a C corporation based in Ohio, is considering whether to create a new position for a CPA. Here are the fixed costs associated with the potential hire:

Salary:  $50,000

Employer portion of the Social Security payroll tax (FICA):  $3,100  ($50,000 x 6.2% of first $90,000 of wages)

Employer portion of the Medicare payroll tax (FICA):  $725  ($50,000 x 1.45% of all wages)

Federal Unemployment Tax (FUTA):  $56  ($7,000 x 0.8% if covered by state unemployment, applies to first $7,000 of wages)

State Unemployment Tax:  $180  ($9,000 x 2% of first $9,000 of wages... Note the rate starts at 5.8% and lowers on a yearly basis based on company experience. I used 2% largely because I'm drinking a glass of 2% milk at the moment.)

State Disability Insurance (Worker's Compensation): $1,250  ($50,000 x 2.5%... For an accountant working both in-office and outside at clients. If your running construction company in Ohio, your bill is 25% of wages, if you do landscaping, you pay 22%, roofing is 36% and if you trim trees using a bucket truck, you pay 60%. As you can see, SDI is a huge variable, and tends to be high for many blue-collar jobs.)

Basic Health Insurance: Say my candidates are all married with a wife and two kids and no pre-existing medical conditions. I've seen rates run from $200 to $600 per month. Add a pre-existing condition and I've seen it as high as $950 per month. For the sake of argument, we'll go low end:

$3,600  ($300 x 12 months, employer pays 100%)

Total cost of adding a new employee (ignoring office space, telephone, travel, supplies, etc.) works out to be...

$58,911

Update... Oops! Sharp-as-a-tack reader Jeffrey W. pointed out that I had the whole break-even thingy completely wrong. The tax credit actually doesn't change the break-even point for PAC. It remains $58,911. What the tax credit does is shield income over and above the break-even point. For example:

PAC's marginal tax rate is, say 25%. The amount of income shielded by the credit is $12,000. The tax savings are $3,000 if PAC's new accountant can generate $70,911 in revenue. The primary problem is this; the tax credit won't motivate an employer who doesn't think a new employee will generate at least $58,911.

(Sorry about that. It's what happens when I try to write posts about taxes after spending 10 hours working on corporate income tax estimates and payroll tax returns.)

In any event, I still am not a fan of this particular tax credit scheme. It would be very difficult and expensive to administer properly, to put it mildly. If you're intent on blowing money to stimulate, in this case just forget this tax credit and let Dick Durbin build that $18 billion "green" coal plant in Illinois he's all warmed up about (so to speak).

The Liberalization of Tax-Loss Carrybacks

Professional journalism being what it is today, I have yet to see a discussion in the mainstream media about this issue where the journalist(s) in question actually understood what they were talking about.

Yeah, I'm shocked too.

Anyway, here's the deal. Under tax law, the Peasant Accounting Corporation can, when appropriate, utilize tax-loss carrybacks and carryforwards to minimize their taxes over a period of years. Presently companies are allowed to carry back losses two years and carry them forward 20 years. The Obama plan would increase the carryback period from two to five years.

Here's how tax-loss carrybacks and carryforwards work:

In the years 2003 through 2007 the Peasant Accounting Corporation had taxable income of $100,00 per year. In 2008, due to the economy and whatnot, PAC managed to lose $325,000. Under present tax law, PAC would then file amended returns (Form 1120X, or in certain cases, a Form 1139) for 2006 and 2007. The amended returns for each year would use $100,000 of 2008's loss (for a total of $200,000). Then the IRS would send PAC checks for 2006 and 2007 refunding all federal income taxes paid. The remaining $125,000 of 2008's loss are then set aside for use against future profits (hence the term carryforward).

Under the Obama plan, because the carryback period has increased from two to five years, PAC can then amend tax returns for 2005 (applying $100,000 of the 2008 loss) and 2004 (applying the last $25,000 of 2008's loss). PAC receives a couple more checks from Uncle, and doesn't have to wait for profits in future years to qualify for an additional tax refund.

The bottom line is this: Increasing the tax carryback period from two to five years generates a timing difference... Companies don't get more taxes refunded per se, what they get is more of the tax refund now, as opposed to in a year (or more) from now.

Personally, I like this proposal. It will be easy and cheap to administer, will be difficult to defraud or abuse, and could provide meaningful and immediate help in the area of cash flow.

So in my book, Obama's batting about .500 right now. Of course, whether either provision makes into law is anyone's guess.

Comments

[markg8]

Ya should have voted for the guy Dennis. He's an accountant's dream. Here's what I wrote about the $3000
tax credit for jobs created or retained early at TPM:

If a tree falls in the forest and nobody is there to hear it did it actually make a noise?

Well if a $3000 tax cut to an employer to hire or retain an employee doesn't immediately inspire a lot of hiring so what? A tax cut that isn't used doesn't cost the government anything. But once hiring does pick up it'll make the job recovery that much faster.

Remember Bush's jobless recovery of 2002-2005? Want a repeat of that? I don't. So why wouldn't a Democratic president want to promote hiring? We have an $11 trillion dollar debt as it is. We can't afford half a decade of double digit unemployment. Maybe this isn't the best way to do it. But if not then let's hear some better ideas.

[Tim P]

I really appreciate your very simple (they have to be if I can follow them) descriptions of how these proposed tax cuts work.

You're so correct in that if only the mainstream media would break stuff down like this for their readership, they would actually contribute to informed debate about issues that directly affect us. But who are we kidding? That would involve actual work on their part.

Back in the day, when I had my own small electrical contracting business, I did all of my own taxes and payroll. It was successful and when I got out, it funded our house and my return to school to get my EE degree. These days I have seen the light and my wife now does all of our taxes.

[elliottg]

Except your 50k is way above average for non-farm, non-supervisory workers. Median household income may be over 50k, but remember that includes a lot of two-worker families. If you look at this chart http://www.bls.gov/news.release/empsit.t16.htm, it can be seen that your average wage slave makes about 35k per year. So if we say that when the incentive gets to be greater than 10% of the costs, that it makes a difference (say an average compensation rate of about 20k since you have to load it some) then you are looking at a universe of about 25-30% of the non-far, non-supervisory jobs out there. If the stimulus can give you a boost of 1 out of 6 in that universe then you have a goose of 4% to this category of job which would decrease the unemployment rate by about 2% without any multiplier effect whatsoever. Assume a multiplier here of 2 (I'm using a low multiplier since these are not great jobs) and you have got a 4% difference in unemployment. A lot of ifs there, but I think a more realistic analysis than a look at one possible position at Peasant Accounting Corporation. Lots of retail jobs pay around 20k or auto mechanics or home health aides or childcare workers so they may not be jobs as good as working for the Peasant, but they are better than nothing.

[Dennis The Peasant]

If I had used $35,000, the multiplication would have been a lot harder.

As someone who has been involved in a lot of hired decisions over the years (as supervisor, owner, or consulting CPA), I don't just don't think a credit of the magnitude we are discussing (10+%) will make a difference.

I have a fair number of clients who hire in the range of $20,000 to $35,000 (landscapers, roofers, construction) and a $3,000 credit just wouldn't move them. Make it a credit of $10,000, and they'd be interested, but $3,000? Nope.

[markg8]

I don't think any stimulus except direct government hiring or contracts to firms doing business with government is going to do much to create jobs right now. The entire world's economy is shrinking so any size jobs tax credit is at odds with the realities of falling demand.

But once we start rising out of the recession/depression (whatever it is) such a credit can help increase hiring a bit faster. Like a lot of things floating around in the stimulus proposal this provision might not make it into this year's final bill. But at least Obama is laying down a marker showing he's open to such ideas. And if that helps keep Republicans engaged instead of in open revolt that's a good thing.

These kind of proposals may not draw votes from John Boehner and Mitch McConnell but it might bring over the likes of Voinovich and the dimwitted real estate salesman from Columbus who represents you Dennis.

[elliottg]

Well, he's batting 1.000 now because he punted on the jobs tax credit.