Wednesday, October 14, 2009

It's Smart to Delay Hiring Early in a Recession

Copyright, The New York Times Company

Politicians in Washington are now considering a tax credit for businesses that expand the size of their work forces. Unfortunately, the mere fact that they are considering this policy is doing harm even before it becomes law.

One problem with the credit comes from the basic arithmetic of employment. The number of an employer’s new hires during a year is equal to its employment at the end of the year minus its employment at the beginning of the year plus the number of people laid off (or quitting) during the year.

Although a credit for new hires could be obtained by having larger payrolls at the end of the year, it could also be obtained — without any change in the size of the payroll – by laying off more people during the year and then replacing (or rehiring) them at the end of the year if and when the subsidy kicks in.

Lawmakers may anticipate some of this behavior by basing the credit on the year’s net employment change: effectively netting out separations (quits and layoffs) from new hires. But of course, this year is not the only year when layoffs occurred; another way a business could enhance its new-hires tax credit is to lay off more employees last year, or at least delay last year’s hiring until this year.

In this case, anticipation of a new hires tax credit was actually making the economy worse before it made it better.

You might say that employers last year had no inkling that a new-hires tax credit was on the horizon. And they can’t exactly go back in time and increase last year’s layoffs to set the stage for a boost this year.

But I expect that a number of employers were aware that government help, when it comes, would be more available for those businesses “in the most trouble.” What better way to spotlight trouble with your business than to lay people off? That’s what happened with federal and state tax policies in some previous recessions. Even this comic strip illustrates the common knowledge that more help goes to businesses that appear to be in greater trouble.

Recall from a previous post a parallel situation with Chicago taxis.

Chicago taxi owners have been delaying their purchases of hybrid taxis because they anticipate that the Chicago City Council will someday pass a subsidy for purchases of hybrid taxis. I doubt that Chicago taxi owners are all that distinct from other American employers in their propensity to think ahead about how next year’s public policies will affect them, and to adjust the timing of their activities accordingly.

Suppose that hardly any employer expected that a new-hires tax credit would be considered before this recession was over. Then it seems that a new-hires tax credit genuinely could do a lot to raise employment.

But how democratic is our government when the success of its policies depends on tricking its own people into thinking it won’t do what it plans to do?
One of the most famous papers in macroeconomics is Robert Lucas' 1976 "Econometric Policy Evaluation: A Critique". There Lucas explains how investment tax credits can be destabilizing because investments are delayed until the government comes along (late in the recession) to offer the credit. I am making the same argument above, because "investment" is nothing more than "new hires" of capital.

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