Image: Barack Obama
Charles Dharapak  /  ASSOCIATED PRESS
President Barack Obama announces economic initiatives for struggling middle class families, Monday in the Eisenhower Executive Office Building in Washington.
updated 1/26/2010 12:35:00 PM ET 2010-01-26T17:35:00

President Barack Obama's promised push to create jobs includes a new tax credit for small businesses that add employees —  an idea that clearly appeals to a nation struggling with a nearly 10 percent unemployment rate.

It is an idea, however, that fell flat in Congress when Obama first proposed it last year because lawmakers didn't know how to target the credit effectively. The Obama administration still hasn't provided details on how the tax credit would work, and some tax experts question whether it would.

"It's very hard to know when a company is incrementally adding jobs because of a tax credit, and when they would have done it anyway," said Eugene Steuerle, a Treasury Department official in the Reagan administration who is now co-director of the Tax Policy Center, a Washington think tank. "I'm sympathetic to subsidizing low-wage jobs. It's just a question of how you design it."

Congressional researchers say a tax credit for firms that increase payroll could be a good way to increase employment, if the credit is available to all companies, not just small businesses. They cautioned, however, that it would be difficult to administer.

Among the issues raised by tax experts:

  • How would the government prevent abuse by companies that artificially increase payroll?
  • How would new companies be treated?
  • How would a firm be prevented from disbanding and reopening under another name just to claim the credit?
  • How would the government ensure firms add long-term employees when the credit is only for a year or two?
  • Would firms be willing to add workers to get a tax credit when consumer demand for their products has not increased?

Clint Stretch, a tax policy expert at Deloitte Tax, said the tax break would help companies that shed jobs last year and were ready to start rehiring this year.

"Guys who were ruthless and threw people out on the street will benefit while those who kept their workers will not," Stretch said.

Renewed focus on job creation
The Obama administration renewed its focus on job creation last week and the president called on Congress to pass a jobs bill that provides "tax breaks to small businesses for hiring people."

Obama first proposed the tax credit late last year, but House Democrats didn't include it in a jobs bill they passed in December. The bill is awaiting action in the Senate. Aides said Obama will focus on job creation in his State of the Union address Wednesday.

The nonpartisan Congressional Budget Office recently analyzed several proposals to create jobs and improve the economy, and concluded that a payroll tax credit for firms that increase payroll would be among the most effective. However, the analysis said limiting the credit to small businesses would reduce the economic benefits.

Major Market Indices

Congress enacted a similar tax credit in the 1970s and few small businesses took advantage, the CBO report said.

Two economists have been promoting a job creation tax credit for the past several months: John H. Bishop, a professor at Cornell University, and Timothy J. Bartik, senior economist at the W. E. Upjohn Institute for Employment Research in Michigan. Video: Job losses paint bleak picture

Under their proposal, businesses that increase their payrolls by more than 3 percent over 2009 levels would get tax credits worth 15 percent of the increase. The tax credit would only apply to the first $50,000 of a worker's salary, capping the amount at $7,500 per worker.

Big and small employers would be eligible, and the credit would be available for existing workers who get raises or more hours, as long as payroll is increased for employees making less than $50,000. The tax credits would be refundable, meaning employers would get them as payments, even if they don't owe any taxes.

Bishop said companies that hire workers, increase hours or increase wages would all be helping the economy.

"We're trying to find a way to lower the cost of adding labor," Bishop said. "The job creation tax credit has the highest bang for buck."

Two senators, noting the "lukewarm" response to Obama's proposal in Congress, have come up with a plan for a payroll tax credit for businesses that hire workers who have been unemployed at least 60 days.

The proposal, by Democratic Sen. Chuck Schumer of New York and Republican Sen. Orrin Hatch of Utah, would exempt businesses from paying the employers' share of Social Security taxes on those workers for the rest of 2010. The plan would save companies 6.2 percent of the workers' salaries that are subject to Social Security taxes.

The money would be repaid to Social Security over the next five years from unspecified budget savings.

Copyright 2010 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.

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