Business Investment and Employment Tax
Incentives to Stimulate the Economy

Thomas L. Hungerford
Specialist in Public Finance
Jane G. Gravelle
Senior Specialist in Economic Policy
January 6, 2012
Congressional Research Service
7-5700
www.crs.gov
R41034
CRS Report for Congress
Pr
epared for Members and Committees of Congress

Business Investment and Employment Tax Incentives to Stimulate the Economy

Summary
According to the Business Cycle Dating Committee of the National Bureau of Economic
Research (NBER), the U.S. economy was in recession from December 2007 to June 2009.
Congress passed and the President signed an economic stimulus package, the American Recovery
and Reinvestment Act of 2009 (P.L. 111-5), in February 2009. The $787 billion package included
$286 billion in tax cuts to help stimulate the economy. Among the tax reductions, many were tax
incentives directed to business. The preliminary estimate of fourth quarter real gross domestic
product (GDP) growth is 5.9%; the unemployment rate, a lagging indicator, averaged 9.6% in the
third quarter and 10.0% in the fourth quarter of 2009. Federal Reserve Chairman Ben Bernanke
expects the economy to continue growing at a modest pace, but predicts that bank lending will
remain constrained and the job market will remain weak into at least 2010. To further assist
unemployed workers, help business, and stimulate housing markets, Congress passed the Worker,
Homeownership, and Business Assistance Act of 2009 (P.L. 111-92). The Obama Administration
has advocated further business tax incentives to spur investment and employment, especially for
small business. The House and Senate passed the Hiring Incentives to Restore Employment
(HIRE) Act, which includes an employment tax credit. The President signed the act into law on
March 18, 2010. In December 2010, P.L. 111-312 extended and expanded the business tax
provisions, among other provisions, including a temporary reduction in the employee’s portion of
the payroll tax.
Several proposals, largely relating to the extension and increase of the temporary payroll tax,
included further investment incentives as well as reductions in payroll taxes by employers. While
a payroll tax on the individual side expands demand in the same way as other income tax cuts, the
employer tax forgiveness is similar to an employer-side wage subsidy, which acts through a
different mechanism.
The two most common measures to provide business tax incentives for new investment are
investment tax credits and accelerated deductions for depreciation. The evidence, however,
suggests that a business tax subsidy may not necessarily be the best choice for fiscal stimulus,
largely because of the uncertainty of its success in stimulating aggregate demand. If such
subsidies are used, however, the most effective short-run policy is probably a temporary
investment subsidy. Permanent investment subsidies may distort the allocation of investment in
the long run.
Employment and wage subsidies are designed to increase employment directly by reducing a
firm’s wage bill. The tax system is a frequently used means for providing employment subsidies.
Most of the business tax incentives for hiring currently under discussion are modeled partially on
the New Jobs Tax Credit (NJTC) from 1977 and 1978. Evidence provided in various studies
suggests that incremental tax credits have the potential of increasing employment, but in practice
may not be as effective in increasing employment as desired. There are several reasons why this
may be the case. First, jobs tax credits are often complex and many employers, especially small
businesses, may not want to incur the necessary record-keeping costs. Second, since eligibility for
the tax credit is determined when the firm files the annual tax return, firms do not know if they
are eligible for the credit at the time hiring decisions are made. Third, many firms may not even
be aware of the availability of the tax credit until it is time to file a tax return. Lastly, product
demand appears to be the primary determinant of hiring, and this issue would affect the
effectiveness of a payroll tax holiday on the employer side.
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Business Investment and Employment Tax Incentives to Stimulate the Economy

Contents
The State of the Economy................................................................................................................ 2
Investment ................................................................................................................................. 3
Employment .............................................................................................................................. 4
Investment Subsidies ....................................................................................................................... 7
Empirical Evidence on the Effectiveness of Investment Incentives.......................................... 8
Direct Effects of Investment Incentives on Employment........................................................ 10
Employment Subsidies .................................................................................................................. 11
Empirical Evidence on the Effectiveness of Employment Subsidies ...................................... 11
Proposals in the 111th Congress ............................................................................................... 14
Proposals in the 112th Congress............................................................................................... 15
Concluding Remarks ..................................................................................................................... 16

Figures
Figure 1. Industrial Production Index: 1990-1991, 2001, and 2007-2009 Recessions .................... 2
Figure 2. Industrial Production Index: 1973-1975, 1981-1982, and 2007-2009 Recessions........... 3
Figure 3. Real Investment Growth in Five Recessions.................................................................... 4
Figure 4. Employment Levels During the 1990-1991, 2001, and 2007-2009 Recessions............... 5
Figure 5. Employment Levels During the 1973-1975, 1981-1982, and 2007-2009
Recessions .................................................................................................................................... 6
Figure 6. Unemployment Rate and Long-Term Unemployment Rate............................................. 7

Contacts
Author Contact Information........................................................................................................... 17

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Business Investment and Employment Tax Incentives to Stimulate the Economy

ccording to the Business Cycle Dating Committee of the National Bureau of Economic
Research (NBER), the U.S. economy was in recession from December 2007 to June
A 2009.1 Congress passed and the President signed an economic stimulus package, the
American Recovery and Reinvestment Act of 2009 (P.L. 111-5), in February 2009. The $787
billion package included $286 billion in tax cuts to help stimulate the economy. Among the tax
reductions, many were tax incentives directed to business. The estimated revenue losses of the
business tax incentives are $40 billion for FY2009, $36 billion for FY2010, and $6 billion for
FY2009-FY2019 (because of estimated revenue gains in the out years). The business tax
incentives included a temporary expansion of the work opportunity tax credit, a temporary
increase of small business expensing, a temporary extension of bonus depreciation, and a five-
year carry back of 2008 net operating losses for small businesses.
The preliminary estimate of fourth quarter real gross domestic product (GDP) growth is 5.9%; the
unemployment rate, a lagging indicator, averaged 9.6% in the third quarter and 10.0% in the
fourth quarter of 2009. Federal Reserve Chairman Ben Bernanke expects the economy to
continue growing at a modest pace, but predicts that bank lending will remain constrained and the
job market remain weak into at least 2010.2 To further assist unemployed workers, help business,
and stimulate housing markets, Congress passed the Worker, Homeownership, and Business
Assistance Act of 2009 (signed by the President on November 6, 2009, P.L. 111-92).
Many observers have advocated further business tax incentives to spur investment and
employment. Recent op-ed contributors have proposed tax credits to encourage businesses to
hire.3 The Obama Administration has proposed tax incentives for small businesses to encourage
investment and hiring. The House and Senate passed the Hiring Incentives to Restore
Employment (HIRE) Act, which includes an employment tax credit. The President signed the act
into law on March 18, 2010.4 In December 2010, P.L. 111-312 extended and expanded the
business tax provisions.
Some proposals would expand the reduction in payroll taxes for individuals and to extend it to
employers. While a payroll tax on the individual side expands demand in the same way as other
income tax cuts, the employer tax forgiveness is similar to an employer-side wage subsidy, which
acts through a different mechanism.

1 NBER defines a recession as a “significant decline in economic activity spread across the economy, lasting more than
a few months” (http://www.nber.org/cycles/cyclemain.html).
2 Ben S. Bernanke, “On the Outlook for the Economy and Policy,” speech at the Economic Club of New York,
November 16, 2009, available at http://www.federalreserve.gov/newsevents/speech/bernanke20091116a.htm.
3 See, for example, Mark Zandi, “Help Small Businesses Hire Again,” New York Times, November 3, 2009, p. A35;
Robert Pozen, “Give Credit to Create Jobs-But Only Where It’s Due,” Financial Times, November 4, 2009, p. 11; and
Charles E. Schumer and Orrin G. Hatch, “A Payroll Tax Break for Jobs,” New York Times, January 26, 2010, p. A23.
4 Congress passed the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 in
December 2010 (signed by the President on December 17, 2010; P.L. 111-312). In addition to extending the Bush tax
cuts for two years and providing temporary alternative minimum tax relief, the act provided for a one-year payroll tax
reduction to stimulate the economy. The payroll tax reduction, however, is designed to increase aggregate demand
rather than to encourage firms to hire new employees.
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The State of the Economy
The need for tax incentives to boost economic activity depends on the state of the economy. One
measure that has tracked economic activity fairly well in the past is the Federal Reserve Board’s
industrial production index, which is used by NBER in its determination of the economy’s turning
points.5 Figure 1 and Figure 2 show the monthly industrial production index for the five past
recessions. The index is followed from the beginning of each recession (month 0 in the figures)
and for the next 36 months.6 Figure 1 compares the trend in the industrial production index for
the previous two recessions (the 1990-1991 recession and 2001 recession) with the recently ended
recession (the 2007-2009 recession—the dashed line). The first two recessions lasted for eight
months according to NBER; the industrial production index in both cases started to track upward
eight months after the recession started.7 In the 2007-2009 recession, however, the industrial
production index was still declining eight months after the recession started and continued to
trend downward for the next 10 months.
Figure 1. Industrial Production Index: 1990-1991, 2001, and 2007-2009 Recessions
110
105
1990-91 Recession
100
2001 Recession
95
x
de
In
n

90
ctio
85
rodu
2007-09 Recession
al P
80
stri
Indu
75
70
65
60
0 1 2 3 4 5
6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36
Months After Start of Recession

Source: CRS analysis of Federal Reserve Board data.

5 The production index measures real output in the manufacturing, mining, and electric and gas utilities industries. See
http://www.federalreserve.gov/releases/g17/About.htm.
6 The index is rescaled so that it equals 100 in the month the recession started.
7 The end of the 1990-1991 and 2001 recessions is denoted by the vertical line in the figure.
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Figure 2 compares the 2007-2009 recession with the 1973-1975 and 1981-1982 recessions. The
latter recessions lasted for 16 months according to NBER, and the industrial production index
bottomed out at the end of each recession.8 The trend in index for the 2007-2009 recession
appears to approximately track the trend over the other two recessions. In the current recession,
the index declined between December 2007 and June 2009, before turning up. The data on real
GDP growth and industrial production suggest that economic activity (that is, output) began
increasing in July 2009; NBER determined that the recession lasted for 18 months. The tax
incentives to enhance economic activity being discussed, however, do not target output. Rather,
they target investment and employment.
Figure 2. Industrial Production Index: 1973-1975, 1981-1982, and 2007-2009
Recessions
110
105
1973-75 Recession
1981-82 Recession
100
95
x
de
In
n

90
ctio
85
rodu
2007-09 Recession
al P
80
stri
Indu
75
70
65
60
0 1 2 3 4 5
6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36
Months After Start of Recession

Source: CRS analysis of Federal Reserve Board data.
Investment
Investment spending by firms tends to decrease in a recession. Figure 3 displays the quarterly
growth rates for real nonresidential gross investment (i.e., business investment) for the quarter in
which the recession started and the subsequent 10 quarters for five recessions. Each recession is
different, but generally by the third quarter after the start of the recession real investment growth
is negative and remains negative for the next four quarters. During the 2007-2009 recession, the

8 The end of the 1973-1975 and 1981-1982 recessions is denoted by the vertical line in the figure.
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decline in real investment spending was particularly severe in the fourth and fifth quarters
compared to the other four recessions.
Figure 3. Real Investment Growth in Five Recessions
40
1973-75 Recession
1981-82 Recession

30
1990-91 Recession
2001 Recession
2007-09 Recession

20
10
e
ang
h

0
C
0
1
2
3
4
5
6
7
8
9
10
tage -10
en
erc
P

-20
-30
-40
-50
Quarters After Start of Recession

Source: CRS analysis of Bureau of Economic Analysis data.
Not all gross investment is used to add to the capital stock; some is used to replace worn-out
capital goods (i.e., consumption of fixed capital or depreciation). In 2008, about 75% of gross
investment spending replaced the value of worn-out fixed assets (this percentage has varied
between 57% and 83% over the past 40 years); the other 25% increased the capital stock. The
consumption of fixed assets as a percentage of gross nonresidential investment stood at 60% in
1970; it increased by 15 percentage points between 1970 and 2008 (reaching 83% in 2003).
Overall, net nonresidential investment as a percentage of GDP has been trending downward—
falling from 4.1% in 1970 to 3.0% in 2008.
Employment
Employment fell for 22 months after the start of the 2007-2009 recession in December 2007.
Figure 4 and Figure 5 show employment for the first month of the recession and the subsequent
36 months for the 2007-2009 recession and four other recessions. Employment is shown as an
employment index (i.e., as the percentage of employment in the first month of the recession).
Employment typically lags the recovery in output by a few months in part because employers are
likely to restore the hours worked by employees still on their payrolls before recalling those laid
off or hiring new workers.
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The 2007-2009 recession is compared with the previous two recessions—the 1990-1991 and 2001
recessions—in Figure 4. Although the previous two recessions were relatively mild and short
(lasting for eight months), employment levels were either stagnant (the 1990-1991 recession) or
declining (the 2001 recession) for several months after the end of the recession. For example,
employment hit bottom 21 months after the 2001 recession ended. In the 2007-2009 recession,
employment levels declined slightly over the first 9 months of the recession and then fell sharply
over the next 12 months. Employment stood at 94% of the December 2007 employment level 25
months after the start of the recession. Employment started to turn up 8 months after the end of
the recession.
Figure 4. Employment Levels During the 1990-1991, 2001, and 2007-2009 Recessions
104
102
100
1990-91 Recession
ex
d

98
In
nt
e

2001 Recession
m
oy

96
pl
m
E

2007-09 Recession
94
92
90
0 1 2 3 4 5
6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36
Months After Start of Recession

Source: CRS analysis of Bureau of Labor Statistics data.
Figure 5 compares the employment levels during the recently ended recession with employment
levels during the 1973-1975 and 1981-1982 recessions. These latter two recessions were
relatively deep and prolonged—lasting for 16 months. For these two recessions, the employment
level began increasing within a month or two after the end of the recession (the end of these
recessions is denoted by the vertical line in the figure). In the 2007-2009 recession, employment
levels began to rise eight months after the recession ended.
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Figure 5. Employment Levels During the 1973-1975, 1981-1982,
and 2007-2009 Recessions
106
104
102
1973-75 Recession
100
x
nde
98
t I
en
m

1981-82 Recession
oy
96
pl
2007-09 Recession
m
E

94
92
90
88
0 1 2 3
4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36
Months After Start of Recession

Source: CRS analysis of Bureau of Labor Statistics data.
Weakness in the labor market is further indicated by the proportion of the labor force who have
been unemployed for at least six months (the long-term unemployed). Figure 6 displays the
monthly unemployment and long-term unemployment rates since 1948. The long-term
unemployment rate has generally tracked the unemployment rate over the business cycle. Over a
business cycle, the long-term unemployment rate is at its lowest point at or near the beginning of
a recession and then reaches a peak a few months after the end of the recession (typically within
six to eight months). Like the unemployment rate, the long-term unemployment rate is a lagging
indicator—the labor market does not begin to recover from a recession until some time after the
official end of the recession. After the 1990-1991 and 2001 recessions, however, the long-term
unemployment rate did not reach its peak until 15 and 19 months, respectively, after the recession
ended. The long-term unemployment rate is currently higher than at any time over the past 62
years—throughout 2010, over 4% of the labor force (more than 40% of the unemployed) had
been out of work for six months or more.
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Figure 6. Unemployment Rate and Long-Term Unemployment Rate
12%
10%
8%
6%
4%
2%
0%
Jan-48 Jan-52 Jan-56 Jan-60 Jan-64 Jan-68 Jan-72 Jan-76 Jan-80 Jan-84 Jan-88 Jan-92 Jan-96 Jan-00 Jan-04 Jan-08
Recessions
Unemployment Rate
Long-term Unemployment Rate

Source: CRS analysis of Bureau of Labor Statistics data.
Investment Subsidies
The two most common measures to provide tax incentives for new investment are investment tax
credits and accelerated deductions for depreciation. Investment tax credits provide for a credit
against tax liability for a portion of the purchase price of assets and are often proposed as a
counter-cyclical or economic stimulus measure. Accelerated depreciation speeds up the rate at
which the cost of an investment is deducted.
The investment tax credit was originally introduced in 1962 as a permanent subsidy, but it came
to be used as a counter-cyclical device. It was temporarily suspended in 1966-1967 (and restored
prematurely) as an anti-inflationary measure; it was repealed in 1969, also as an anti-inflationary
measure. The credit was reinstated in 1971, temporarily increased in 1975, and made permanent
in 1976. After that time, the credit tended to be viewed as a permanent feature of the tax system.
At the same time, economists were increasingly writing about the distortions across asset types
that arose from an investment credit. The Tax Reform Act of 1986 moved toward a system that
was more neutral across asset types and repealed the investment tax credit while lowering tax
rates.
Accelerated depreciation tends not to be used for counter-cyclical purposes. At least one reason
for not using accelerated depreciation for temporary, counter-cyclical purposes is because such a
revision would add considerable complexity to the tax law if used in a temporary fashion, since
different vintages of investment would be treated differently. An investment credit, by contrast,
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occurs the year the investment is made and, when repealed, only requires firms with carry-overs
of unused credits to compute credits. An exception to the problem with accounting complexities
associated with accelerated depreciation is partial expensing (that is, allowing a fraction of
investment to be deducted up front and the remainder to be depreciated). This partial expensing
approach also is neutral across all assets it applies to, but the cash flow effects are more
concentrated in the present (and revenue is gained in the future). A temporary partial expensing
provision, allowing 30% of investments in equipment to be expensed over the next two years,
was included in H.R. 3090 in 2002 and expanded to 50% and extended through 2004 in tax
legislation enacted in 2003. It expired in 2004. The Economic Stimulus Act of 2008 (P.L. 110-
185) included temporary bonus depreciation for 2008, which was extended for 2009 by the
American Recovery and Reinvestment Act of 2009 (ARRA; P.L. 111-5). The Obama
Administration recently proposed 100% expensing for qualified capital investments through the
end of 2011. In December 2010, P.L. 111-312 extended and expanded the business tax provisions
by allowing 100% expensing in 2011 and 50% in 2012.
On September 8, 2011, the President proposed a fiscal stimulus that largely related to payroll
taxes, but also proposed to increase expensing to 100% in 2012. This expensing provision was
also included in H.R. 3630, the House Republican proposal that also extended the payroll tax and
made other revisions. This legislation was adopted by the House but not passed. A two-month
extension of payroll tax relief was adopted and the issues are expected to be reconsidered in
January 2012.
The extent to which these business tax breaks are a successful counter-cyclical stimulus hinges on
the effectiveness of investment subsidies in inducing spending. It is difficult to determine the
effect of a business tax cut and the timing of induced investment. A business tax cut is aimed at
stimulating investment largely through changes in the cost (or price) of capital. If there is little
marginal stimulus or if investment is not responsive to these price effects in the short run, then
most of the cut may be saved: either used to pay down debt or paid out in dividends, although
some of the latter might eventually be spent after a lag. That is, if a tax cut simply involved a cash
payment to a firm, most of it might be saved, particularly in the short run. Business tax cuts (of
most types) also have effects on rates of return that increase the incentive to invest, and it is
generally for that reason that investment incentives have been considered as counter-cyclical
devices. Investment incentives through expensing for small businesses, however, are usually
phased-out. As a result, these provisions produce a disincentive to investment over the phase-out
range.9 Consequently, the overall incentive effect is ambiguous.
Empirical Evidence on the Effectiveness of Investment Incentives
Despite attempts to analyze the effect of the investment tax credit, considerable uncertainty
remains. Time series studies of aggregate investment using factors such as the tax credit (or other
elements that affect the tax burden on capital or the “price” of capital) as explanatory variables
tended to find little or no relationship.10 A number of criticisms could be made of this type of
analysis, among them the possibility that tax subsidies and other interventions to encourage
investment were made during periods of economic slowdown. A recent study using micro data

9 See CRS Report RL31852, Section 179 and Bonus Depreciation Expensing Allowances: Current Law, Legislative
Proposals in the 112th Congress, and Salient Economic Effects
, by Gary Guenther
10 A summary of this early literature can be found in several sources. For a non-technical summary, see Jane G.
Gravelle, The Economic Effects of Taxing Capital Income, Cambridge, MIT Press, 1994, pp. 118-120.
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found an elasticity (the percentage change in investment divided by the percentage change in the
user cost of capital) for equipment of -0.25.11 A widely cited study by Cummins, Hassett, and
Hubbard used panel data and tax reforms as “natural experiments” and found effects that suggest
a price elasticity of -0.66 for equipment.12 Although the second estimate is higher, both are
considered inelastic (less than a unitary elasticity) implying that induced spending is less than the
cost.
This last estimate is a higher estimate than had previously been found and reflects some important
advances in statistical identification of the response. Yet, it is not at all clear that this elasticity
would apply to stimulating investment in the aggregate during a downturn when firms have
excess capacity. That is, firms may have a larger response on average to changes in the cost of
capital during normal times or times of high growth, when they are not in excess capacity.
Certainly, one might expect the response to be smaller in low growth periods.
An additional problem is that the timing of the investment stimulus may be too slow to stimulate
investment at the right time. If it takes an extensive period of time to actually plan and make an
investment, then the stimulus will not occur very quickly compared to a cut in personal taxes that
stimulates consumption immediately. Indeed, the stimulus to investment could even occur during
the recovery when it is actually undesirable.
There is some evidence that the temporary bonus depreciation enacted in 2002 had little or no
effect on business investment. A study of the effect of temporary expensing by Cohen and
Cummins at the Federal Reserve Board found little evidence to support for a significant effect.13
They suggested several potential reasons for a small effect. One possibility is that firms without
taxable income could not benefit from the timing advantage. In a Treasury study, Knittel
confirmed that firms did not elect bonus depreciation for about 40% of eligible investment, and
speculated that the existence of losses and loss carry-overs may have made the investment
subsidy ineffective for many firms, although there were clearly some firms that were profitable
that did not use the provision.14 Cohen and Cummins also suggested that the incentive effect was
quite small (largely because depreciation already occurs relatively quickly for most equipment),
reducing the user cost of capital by only about 3%; that planning periods may be too long to
adjust investment across time; and that adjustment costs outweighed the effect of bonus
depreciation. Knittel also suggested that firms may have found the provision costly to comply
with, particularly because most states did not allow bonus depreciation.
A recent study by House and Shapiro found a more pronounced response to bonus depreciation,
given the magnitude of the incentive, but found the overall effect on the economy was small,
which in part is due to the limited category of investment affected and the small size of the

11 Robert S. Chirinko, Steven M. Fazzarri, and Andrew P. Meyer, “How Responsive is Business Capital Formation to
its User Cost? An Exploration with Micro Data?” Journal of Public Economics vol. 74 (1999), pp. 53-80.
12 Jason G. Cummins, Kevin A. Hassett, and R. Glen Hubbard, “A Reconsideration of Behavior Using Tax Reforms as
Natural Experiments.” Brookings Papers on Economic Activity, 1994, no. 1, pp. 1-72.
13 Darryl Cohen and Jason Cummins, A Retrospective Evaluation of the Effects of Temporary Partial Expensing,
Finance and Economics Discussion Series 2006-19, Federal Reserve Board, Washington, D.C. April 2006. They
compared investment increases for shorter lived and longer lived assets (longer lived assets received a larger incentive)
and investment closer to expiration to test the effects.
14 Matthew Knittel, Corporate Response to Bonus Depreciation: Bonus Depreciation for Tax Years 2002-2004, U.S.
Department of Treasury, Office of Tax Analysis Working Paper 98, May 2007.
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incentive.15 Their differences with the Cohen and Cummins study reflect in part uncertainties
about when expectations are formed and when the incentive effects occur.
Cohen and Cummins also reported the results of several surveys of firms, where from two-thirds
to over 90% of respondents indicated bonus depreciation had no effect on the timing of
investment spending. Overall, bonus depreciation did not appear to be very effective in providing
short-term economic stimulus.
There are reasons to expect that tax incentives for equipment might have limited effects in
stimulating investment in the short run, primarily because of planning lags and because of the
slowness of changing the technology of production. Essentially, there are two reasons that firms
may increase investment. First, they may expect output to increase. This response, called the
accelerator, is a result of other forces that increase aggregate demand thus requiring making more
of the same type of investment (along with hiring more workers). The second reason is that the
cost of investment has fallen. Part of this effect may be an output effect since the overall cost of
investment is smaller, output can be sold at a lower price with an expectation that sales will rise in
the future. Also part of this effect has to do with encouraging more use of capital relative to labor.
This analysis suggests that a business tax subsidy may not necessarily be the best choice for fiscal
stimulus, largely because of the uncertainty of its success in stimulating aggregate demand. If
such subsidies are used, however, the most effective short-run policy is probably a temporary
investment subsidy. Permanent investment subsidies may distort the allocation of investment in
the long run.
Direct Effects of Investment Incentives on Employment
The objective of investment subsidies is to increase spending which, in turn, should lead to
increased employment (first in the capital goods manufacturing sector, and then in the economy
as a whole through multiplier effects). Investment subsidies could also, however, have a direct
effect on employment within the firm receiving the subsidy because they change relative prices.
Capital and skilled labor (i.e., more educated workers) tend to be complements, that is, they are
used together in the production process.16 Consequently, increasing the amount of capital tends to
increase the demand for skilled labor. Furthermore, capital and unskilled labor (i.e., less-educated
workers) tend to be substitutes. Thus, increasing investment could reduce the demand for less-
skilled labor. These labor market effects could show up in one of two ways: changes in wages or
employment levels. Unfortunately, there are no studies estimating the direct impact of investment
incentives on employment.
One study examined the effect of investment subsidies on the prices of capital goods and wages
of workers in the capital goods producing industry.17 Goolsbee found that benefit of investment
tax incentives generally went to the producers of capital equipment through higher capital prices
and somewhat higher wages for workers in the capital goods industry. Overall, it appears that

15 Christopher House and Matthew Shapiro, “Temporary Investment Tax Incentives: Theory with Evidence from Bonus
Depreciation,” American Economic Review, vol. 98, no. 3 (June 2008), pp. 737-768.
16 See Daniel S. Hamermesh, Labor Demand (Princeton, NJ: Princeton University Press, 1993), pp. 110-122.
17 Austan Goolsbee, “Investment Tax Incentives, Prices, and the Supply of Capital Goods,” Quarterly Journal of
Economics
, vol. 113, no. 1 (February 1998), pp. 121-148.
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investment incentives could reduce the demand of less-educated workers (a group with a
relatively high unemployment rate), and increase the demand for highly educated workers (a
group with a relatively low unemployment rate) and workers in capital goods producing
industries. It is not clear, however, whether these effects would occur in a slack economy.
Employment Subsidies
Employment and wage subsidies are designed to increase employment directly by reducing a
firm’s wage bill. A firm’s wage bill for labor includes wages and salaries paid to employees, the
cost of fringe benefits (e.g., health insurance and pensions), hiring costs, and taxes paid such as
the employer’s share of the payroll tax.18 These subsidies can take many forms. For example,
earnings or time spent working can be subsidized. Furthermore, the subsidies can be incremental
or non-incremental—that is, new hires are subsidized or all workers are subsidized. The subsidies
can be targeted to certain groups of workers such as disadvantaged individuals, or can be
available for any worker.
The tax system is a frequently used means for providing employment subsidies. Currently, the
Work Opportunity Tax Credit (WOTC), a nonrefundable credit, is available to employers who
hire individuals from 11 targeted disadvantaged groups.19 Another example of an employment tax
credit is the New Jobs Tax Credit (NJTC) from 1977 and 1978. It was an incentive to business to
hire employees in excess of a base amount.
Most of the business tax incentives for hiring discussed in the 111th Congress were modeled
somewhat on the NJTC. The NJTC was an incremental jobs tax credit in that the employer had to
increase the Federal Unemployment Tax Act (FUTA) wage base above at least 102% of the FUTA
wage base in the previous year. The credit was 50% of the increase in the FUTA wage base (the
wage base consisted of wages paid up to $4,200 per employee). The employer’s income tax
deduction for wages, however, was reduced by the amount of the credit. Consequently, the
effective maximum credit for each new employee ($2,100 minus the additional tax due from the
reduced deduction) ranged from $1,806 for taxpayers in the 14% tax bracket to $630 for
taxpayers in the 70% tax bracket. Furthermore, the total credit could not exceed $100,000, which
in effect limited the size of the subsidized employment expansion at any one firm to 47. The
credit was nonrefundable but could be carried back for three years and forward for seven years.
Empirical Evidence on the Effectiveness of Employment Subsidies
Employment and wage subsidies have been analyzed since at least the 1930s, but few of the
analyses include empirical estimates of the effects of the subsidies. In an early theoretical analysis
of a nonincremental wage subsidy, Arthur Pigou concluded that a wage subsidy could increase
employment but “in practice it is probable that the application of such a system would be
bungled.”20 Nicholas Kaldor, however, in another theoretical analysis, argued that a temporary

18 Labor costs are a deductable business expense for income tax purposes.
19 The American Recovery and Reinvestment Act of 2009 (ARAA; P.L. 111-5) temporarily added two new groups:
unemployed veterans and disconnected youth. The other nine groups include welfare recipients, ex-felons, and summer
youth among others. This tax credit expires on August 31, 2011. See CRS Report RL30089, The Work Opportunity Tax
Credit (WOTC)
, by Christine Scott, for more information.
20 Arthur C. Pigou, The Economics of Welfare, 4th ed. (London: MacMillan and Co., 1932), p. 704.
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incremental wage subsidy to deal with cyclical unemployment could be very effective.21 In a
more recent theoretical analysis, Richard Layard and Stephen Nickell also argue that a temporary
incremental wage subsidy could be effective in increasing employment when unemployment is
high.22
In the United States, employment subsidies have often been offered through the tax system. Two
major tax programs to subsidize employment that have been evaluated are the New Jobs Tax
Credit (NJTC) and the Targeted Jobs Tax Credit (TJTC); the TJTC was a targeted hiring subsidy
that was replaced by the WOTC. The NJTC was explicitly designed to be a counter-cyclical
employment measure to boost employment after the 1973-1975 recession.
The NJTC was enacted in May 1977 at a time when the economy had begun to recover from the
recession and was already growing. The credit was incremental in that it applied only to
employment greater than 102% of the previous year’s employment level. For each new eligible
worker hired, a firm received a tax credit of 50% of wages paid up to $4,200 (the maximum gross
credit for each new employee, therefore, was $2,100). The credit had an aggregate $110,000 cap
so that the majority of benefits went to small firms. Once the cap was reached, the firm received
no subsidy for hiring additional workers. Thus very large firms whose employment grew
substantially more than 2% may not have had a marginal incentive. In addition, the credit was
allowed against income tax liability and firms without adequate tax liability were not able to use
all (or in some cases, any) of the credit.
The first evaluation of the NJTC used responses from a federal survey of for-profit firms. Jeffrey
Perloff and Michael Wachter compared employment growth of firms that knew about the tax
credit to firms that did not know about the credit.23 They find that employment at the firms with
knowledge of the credit grew about 3% faster than at the other firms. They note, however, that
only 34% of the firms knew about the tax credit and these firms were probably not randomly
drawn—it is possible that the firms most likely to hire workers were also more likely to seek out
tax benefits. They caution that their results may overstate the NJTC’s employment effect.
A second evaluation by John Bishop focused on the employment effects of the NJTC in the
construction and distribution industries.24 Bishop’s key explanatory variable is the proportion of
firms in the industry that knew about the tax credit. He estimates that the NJTC was responsible
for 150,000 to 670,000 of the 1,140,000 increase in employment in these industries. The
estimated effect, however, varies dramatically from industry to industry and sometimes from one
empirical specification to another for the same industry. The results of both Perloff and Wachter,
and Bishop suggest that the NJTC may have been somewhat successful in increasing
employment, but showing a relationship between knowledge of the NJTC and employment gains
does not mean that one caused the other.

21 Nicholas Kaldor, “Wage Subsidies as a Remedy for Unemployment,” Journal of Political Economy, vol. 44, no. 6
(December 1936), pp. 721-742.
22 P.R.G. Layard and S.J. Nickell, “The Case for Subsidizing Extra Jobs,” Economic Journal, vol. 90, no. 357 (March
1980), pp. 51-73.
23 Jeffrey M. Perloff and Michael L. Wachter, “The New Jobs Tax Credit: An Evaluation of the 1977-78 Wage Subsidy
Program,” American Economic Review, papers and proceedings, vol. 69, no. 2 (May 1979), pp. 173-179.
24 John Bishop, “Employment in Construction and Distribution Industries: The Impact of the New Jobs Tax Credit,” in
Studies in Labor Markets, ed. Sherwin Rosen (Chicago: University of Chicago Press, 1981), pp. 209-246.
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Not all evaluations of the NJTC were positive. Robert Tannenwald analyzed data from a survey
of private firms in Wisconsin and concludes that the NJTC did not live up to expectations.25 He
estimates that the per job cost of the NJTC was greater than public service employment programs.
Over half of the firms that did not expand employment in response to the tax credit said that
consumer demand for their product determines the level of employment.26 Some firms reported
they were reluctant to take advantage of the tax credit because of its complexity.
Emil Sunley argues that there was a gap between the time of the hiring decision and the time
eligibility for the credit was determined.27 He notes that because the capital stock is essentially
fixed in the short run, an increase in employment will only come about because of an increase in
product demand. Furthermore, it automatically favors firms that are already growing, which could
increase geographic differentials in job creation.
A report on the NJTC commissioned by Congress from the Department of Labor and the
Department of Treasury also was skeptical of the effectiveness of the subsidy.28 In a mail survey,
only about one-third of firms knew about the credit (although these firms covered 77% of
employees). About 20% both knew about the credit and qualified for it (covering 58% of
employees). However, when firms were asked, only 2.4% of firms indicated that they made a
conscious effort to hire because of the subsidy. Similar effects were found in a survey of the
National Federation of Independent Businesses (NFIB), which covers smaller employers. Their
survey results indicated that from 1.4% to 4.1% of employers were affected by the subsidy.
The Labor/Treasury study also raised questions about the studies by Perloff and Wachter, and by
Bishop. They noted that the former study used data for 1977 and the credit was not enacted until
May 1977. They questioned the latter author’s lack of tests for significance of the wage variable.
In addition, since the credit came at a time when the economy was already growing, it is possible
that the credit may have shifted employment from one sector to another rather than increased
aggregate employment.
Evaluation of other employment tax credit programs also yield mixed results.29 The Targeted Jobs
Tax Credit (TJTC) provided a wage subsidy to firms for hiring eligible workers (e.g., welfare
recipients, economically disadvantaged youth, and ex-offenders). One study by Kevin Hollenbeck
and Richard Willke found that the TJTC improved employment outcomes for nonwhite youth but
not for other eligible individuals.30 Bishop and Mark Montgomery estimate that the TJTC induced
some new employment, but at least 70% of the tax credits were claimed for hiring workers who
would have been hired even in the absence of the tax credit.31 Dave O’Neill concludes that

25 Robert Tannenwald, “Are Wage and Training Subsidies Cost-Effective? Some Evidence from the New Jobs Tax
Credit,” New England Economic Review, September/October 1982, pp. 25-34.
26 For example, one firm reported that “orders determine levels of hiring, not tax gimmicks” (Tannenwald, p. 31).
27 Emil M. Sunley, “A Tax Preference in Born: A Legislative History of the New Jobs Tax Credit,” in The Economics
of Taxation
, ed. Henry J. Aaron and Michael J. Boskin (Washington: Brookings Institution, 1980), pp. 391-408.
28 Departments of Labor and Treasury, The Use of Tax Subsidies for Employment, A Report to Congress, Washington,
May 1986.
29 For a summary of other studies examining the TJTC, see CRS Report 95-981, The Targeted Jobs Tax Credit, 1978-
1994
, by Linda Levine, which is available on request from the authors.
30 Kevin M. Hollenbeck and Richard J. Willke, The Employment and Earnings Impacts of the Targeted Jobs Tax
Credit
, Upjohn Institute, Staff Working Paper 91-07, Kalamazoo, MI, February 1991.
31 John H. Bishop and Mark Montgomery, “Does the Targeted Jobs Tax Credit Create Jobs at Subsidized Firms?”
Industrial Relations, vol. 32, no. 3 (Fall 1993), pp. 289-306.
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programs targeted to narrow socioeconomic groups are unlikely to “achieve the desired effect of
significantly increasing the employment level of the target group.”32
Taken together, the results of the various studies suggest that incremental tax credits have the
potential of increasing employment, but in practice may not be as effective in increasing
employment as desired. There are several reasons why this may be the case. First, jobs tax credits
are often complex (so as to subsidize new jobs rather than all jobs) and many employers,
especially small businesses, may not want to incur the necessary record-keeping costs. Second,
since eligibility for the tax credit is determined when the firm files the annual tax return, firms do
not know if they are eligible for the credit at the time hiring decisions are made. Third, many
firms may not even be aware of the availability of the tax credit until it is time to file a tax return.
Additionally, the person making the hiring decision is often unaware of tax provisions and the tax
situation of the firm. Lastly, product demand appears to be the primary determinant of hiring.
Proposals in the 111th Congress
The Obama Administration proposed a $5,000 business tax credit against payroll taxes for every
net new employee they hire in 2010; the credit would have a $500,000 aggregate cap per firm. In
addition, small businesses that increase wages or expand hours would get a credit against added
payroll taxes. The proposals tried to overcome some of the limitations of the NJTC. For example,
the proposal would have allowed firms to claim the credits on a quarterly rather than an annual
basis. All firms would have qualified for the tax credit since it would have been allowed against
payroll taxes rather than income taxes (over half of all firms were not eligible for the full 1977-
1978 NJTC because of insufficient income tax liability). The credit would have also been
available for nonprofits and startups would be eligible for half the credit. The Administration
estimated that this proposal would cost $33 billion.
Senators Baucus and Grassley (the chairman and ranking minority Member of the Senate Finance
Committee, respectively) proposed the Hiring Incentives to Restore Employment (HIRE) Act on
February 11, 2010. Their proposal included two tax incentives for hiring and retaining
unemployed workers. This proposal was enacted in the Hiring Incentives to Restore Employment
(HIRE) Act (P.L. 111-147), which was signed by the President on March 18, 2010. It is estimated
that the tax incentives would cost $13 billion over 10 years.
The first tax incentive in the HIRE Act was forgiveness of the employer’s share of the 2010
payroll tax (6.2% of the worker’s earnings) for qualified workers hired in 2010 after enactment of
the proposal. A qualified worker is an individual who was unemployed for at least 60 days and
does not replace another worker at the firm unless the replaced worker left voluntarily or for
cause. Verifying that these conditions were met was difficult. Furthermore, an employer could not
take advantage of both the payroll tax forgiveness and WOTC; consequently, employers may
have hired the long-term unemployed rather than individuals from other disadvantaged groups.
Firms with no or little income tax liability (including nonprofits) were eligible for the payroll tax
forgiveness and the benefits were received on a quarterly rather than annual basis.
The second tax incentive was a business credit for retention of newly hired qualified workers.
Employers are allowed a $1,000 business tax credit for each qualified worker who remains

32 Dave M. O'Neill, “Employment Tax Credit Programs: The Effects of Socioeconomic Targeting Provisions,” Journal
of Human Resources
, vol. 17, no. 3 (Summer 1982), p. 449.
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employed for 52 weeks at the firm. Since this is an income tax credit, the employer does not
receive the benefits of retaining workers until they file their 2011 income returns in early 2012.
Furthermore, firms with little or no tax liability (including nonprofits) cannot take full advantage
of this incentive since the credit is nonrefundable.33
Another proposal for a job creation tax credit was also modeled partially on the NJTC and, like
the Administration’s proposal, tried to correct some of the flaws that may have limited the
effectiveness of the NJTC.34 The credit would have been equal to 15% of additional taxable
payroll (i.e., payroll subject to Social Security taxes) in 2010 and to 10% of additions to taxable
payroll in 2011. This tax credit would have been refundable so both unprofitable firms and non-
profits could take advantage of the credit. Furthermore, the benefits of the credit would have been
received on a quarterly basis rather than annually when the firm files an income tax return. Bartik
and Bishop estimated that the tax credit could create 2.8 million jobs in 2010 and 2.3 million jobs
in 2011. They further estimated that the budgetary cost would be no more than $15 billion per
year. Their estimates assumed a labor demand elasticity of 0.3, which indicates that a 10%
reduction in the cost of labor would increase employment by 3%. Their estimates did not rest on a
study of the 1977-1978 credit, but rather predicted the effect on jobs based on a central tendency
labor demand elasticity.35 They also estimated that if the labor demand elasticity were 0.15, then
1.4 million jobs would be created in 2010 and 1.1 million jobs in 2011. Note that this estimate is a
general demand elasticity, and might not necessarily be as high during a recession, when business
is slack.36
Proposals in the 112th Congress
President Obama proposed a new set of tax cut and spending programs on September 8, 2011.
The proposed package totals $447 billion, with slightly over half of the package in tax cuts and
the remainder in spending increases.37 This package is considerably larger than the 2008 stimulus
but smaller than the 2009 stimulus. At the President’s request, the American Jobs Act was
subsequently introduced in the House (H.R. 12) and Senate (S. 1549).

33 Unused credits can be carried forward to future tax years but cannot be carried back to past years.
34 Timothy J. Bartik and John H. Bishop, The Job Creation Tax Credit, Economic Policy Institute Briefing Paper,
October 20, 2009, http://www.epi.org/publications/entry/bp248/.
35 See Daniel L. Hamermesh, Labor Demand (Princeton University Press: Princeton, NJ, 1993), for a survey:
Hamermesh suggests a midpoint elasticity of 0.3 on p. 92.
36 Even with the elasticities discussed, only 10% to 30% of the subsidy cost would be reflected in additional wages for
a nonincremental subsidy. With an elasticity of e, dL/L = (-e) dW/W, where L is labor, dL is the change in labor, W is
the wage and dW is the change in wage. Thus for the addition to the wage bill ((W)(dL)), (W)(dL) = (-e)(dW)( L). At a
subsidy rate of s, dW = -sW and the cost of the subsidy is sWL, Thus additional wages, esWL divided by the cost
equals e, the elasticity. The Congressional Budget Office (CBO) estimated the impact of a reduction in the employer’s
share of the payroll tax which is a nonincremental subsidy. CBO estimates that reducing the employer share of payroll
taxes would increase output by $0.40 to $1.30 per dollar of total budgetary cost. This effect is relatively large compared
to other policies and not consistent with the elasticities. CBO did not model the payroll tax holiday as an increase in
labor demand as did Bishop and Bartik; nor did they model it in the same way they model investment subsidies (as an
increase in the demand for capital goods). Rather, they treated it largely as leading directly to a price reduction, similar
to a sales tax holiday. The theoretical and empirical justifications for this approach, however, are not clear. See
Congressional Budget Office, Policies for Increasing Economic Growth and Employment in 2010 and 2011, January
2010. See also testimony by Statement of Douglas W. Elmendorf, Director, Policies for Increasing Economic Growth
and Employment in 2012 and 2013, before the Committee on the Budget United States Senate, November 15, 2011,
http://www.cbo.gov/ftpdocs/124xx/doc12437/11-15-Outlook_Stimulus_Testimony.pdf.
37 Based on White House Fact Sheet, embargoed until the President’s speech on September 8, 2011.
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While most of the tax cuts ($175 billion) would provide an extension and increase in the payroll
tax reduction for 2011, business investment and employment tax subsidies would also be
provided. One provision cuts the employer payroll tax in half for the first $5 million in wages, a
proposal targeting small business. Another provision eliminates the payroll tax for growth in
employer payrolls, up to $50 million. These two provisions together would cost $65 billion,
slightly under 15% of the total. An additional $5 billion would be spent on extending the 100%
expensing (which allows firms to deduct the cost of equipment immediately rather than
depreciating it) through 2012 (where 50% expensing is currently allowed). The bill also has a
$4,000 tax credit for hiring the long-term unemployed ($8 billion) and tax credits from $5,600 to
$9,600 for hiring unemployed veterans (negligible cost). There is more disagreement about the
effectiveness of these types of tax incentives discussed in the following section.
S. 1917 proposed payroll tax changes similar to the President’s proposal, including the cut in
payroll taxes and a hiring credit. This bill was defeated on the Senate floor on December 1. While
a payroll tax on the individual side expands demand in the same way as other income tax cuts, the
employer tax forgiveness is an employer-side wage subsidy. This type of subsidy is not
incremental and it would not be subject to some of the administrative complications of other
credits. At the same time, the “bang for the buck” would likely be smaller, and whether
companies would hire people on a temporary basis during a time of slack demand is uncertain.
Subsequent payroll tax proposals (S. 1931 and S. 1944) did not contain an employer side tax
benefit, although news reports indicate a proposal by Senators Collins and McCaskill would
extend the 2 percentage point employee reduction and allow it on the employer side up to $10
million. Similarly, the House proposal, H.R. 3630 did not contain employer side provisions for
the payroll tax cut. Ultimately the employee side payroll relief was extended for two months and
the issue is expected to be reconsidered on January 2012.
Concluding Remarks
The evidence suggests that investment and employment subsidies are not as effective as desired
in increasing economic activity, especially employment. Economic theory indicates that a deficit-
financed fiscal stimulus designed to increase aggregate demand would have the maximum impact
on employment in the short term. Such policies could include increases in federal government
spending for goods and services, federal transfers to state and local governments, and tax cuts for
low and middle income taxpayers. The short-term benefits of higher deficits, however, could be
outweighed by the long-term costs if deficits are not reduced when unemployment falls.
Additional fiscal stimulus that increases the deficit arguably should be considered in the context
of 2009 and 2010 deficits that were larger relative to the size of the economy than all but a
handful of previous wartime years. The 2009 and 2010 deficits are not sustainable in the long run
in the sense that deficits of that size would cause the national debt to continually rise relative to
output—eventually investors will refuse to continue financing it because they no longer believe
that the government would be capable of servicing it.

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Author Contact Information

Thomas L. Hungerford
Jane G. Gravelle
Specialist in Public Finance
Senior Specialist in Economic Policy
thungerford@crs.loc.gov, 7-6422
jgravelle@crs.loc.gov, 7-7829


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