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A Road to More Employment? Analysing an Employment Allowance for Australia
Phil Hanratty
Economics, Commerce and Industrial Relations Group
Major Issues
Introduction
The Core of the EA Proposal
Could an EA Increase Employment and Help Reduce Unemployment
on a Sustainable Basis ?
Labour Market Substitution
Abuse Through Over-Claiming
Dissipating the EA's Effectiveness Through
Wage Increases
Dissipating the EA's Effectiveness Through Price
Reductions
Inaccurate Targeting of an EA
How Long Should the EA Subsidy Last ?
An Illustrative Example
Financing an EA
Comparisons with the Blandy Scheme
Perverse Equity Effects of an EA ?
Perverse Pro-Cyclical Effects of an EA ?
Tax System Complexity
Does an EA Fit with Existing Active Labour Market
Programs ?
Are There Better Alternatives for Increasing Sustainable
Employment ?
Conclusions
Endnotes
This paper analyses an unusual scheme for increasing aggregate employment,
and thus helping to reduce aggregate unemployment, on a sustainable basis.
This 'Employment Allowance' (EA) scheme operates through the business
taxation system and seeks to increase the financial incentives for businesses
to take on extra workers at the margin. Schemes of this type have long
existed as theoretical ideas but have not, up to now, been implemented
on a nation-wide basis by any country.
Under an EA, businesses (both companies and unincorporated enterprises)
would be offered a tax concession for taking on extra workers above a
certain employment growth threshold. Businesses operating both in Australia
and overseas would be able to claim the extra concession for extra employment
only in the Australian component of their activities.
The financial costs of such employment of extra workers (wages, training,
etc) would attract a deduction of more than 100 per cent in the calculation
of taxation liabilities. The current taxation standard is to allow a deduction
of only 100 per cent. This extra deduction would reduce the effective
cost of such employment, at the margin, to employers and thus encourages
it.
EA schemes can only be effective in reducing underlying employment (which
abstracts from Keynesian-style unemployment which occurs in recessions)
if such unemployment is at least partly caused by real (ie. inflation-adjusted)
labour costs being 'too high' in relation to worker productivity at the
margin of employment. Other causes of underlying unemployment are not
well-suited to attack through EA schemes and require other measures to
improve the quality and flexibility of labour supply.
It seems clear that underlying unemployment levels in Australia are
presently generated in part by excessive real wages at the margin of employment.
However, other factors relating to labour supply have also clearly been
at work here.
All business tax concessions need careful design, because many professional
business advisers have great expertise in using such tax provisions in
unexpected and clever ways to minimise taxation burdens. An EA would require
careful design of several of its features to ensure that it was cost effective
and was not abused.
- The employment growth threshold for each business would need to be
carefully specified in terms of 'effective full-time jobs' rather than
just in terms of numbers of workers employed in any year.
- The magnitude of the EA subsidy would need to be equalised across
all prospective workers, both to reduce overclaiming and to increase
job assistance for low wage workers.
- Careful screening of businesses applying for the EA for the first
time would be necessary to ensure that employment levels in existing
businesses were not disguised as new employment in new businesses.
Fears about the wasting of the effectiveness of an EA through wage increases
and/or price reductions, both of which would eliminate the profits on
extra employment created by the EA scheme, seem much exaggerated. Wage
increases would be contained by the targeting of an EA to extra employment
at the margin and the related reality of the vulnerable position of such
jobs, while price reductions would be unnecessary in many sectors because
of output demand conditions which are strongly sensitive to price changes.
Any remaining adverse developments in wages and prices can be further
contained by strengthening tax incentives to resist wage increases and
by using macroeconomic policy, especially monetary policy, to expand aggregate
demand and thus bolster prices.
It would be important to contain real wage increases for EA-subsidised
positions for the length of the EA. This might require extra policy measures
such as further targeted tax incentives, the creation of special EA job
categories in the industrial relations system and warnings to holders
of EA-subsidised jobs of the need to temporarily forgo such benefits.
As with wage subsidy schemes for specific categories of workers, EA
schemes involve an inherent waste factor, paying tax subsidies on jobs
which would have been created without an EA. Calculations using current
Australian economic data seem to indicate that this waste factor would
be of reasonable, tolerable proportions in the case of an EA. As well,
such a waste component could be reduced by varying the features of the
EA (such as the employment growth threshold) across industries in order
to 'customise' the incentives of the EA to the economic circumstances
of each industry.
An illustrative example of an EA of 10 per cent (ie. a total tax deduction
of 110 per cent of the costs of extra workers) is examined to give readers
a more 'concrete' impression of how such a scheme would work and of how
it might affect the economy. Based upon reasonable assumptions, it is
calculated that such an EA, once fully operational, could increase aggregate
employment by about 80, 000 jobs and probably be self-financing in terms
of its effects upon the public sector's budget balance. This desirable
budget outcome occurs because the extra employment and national income
generated would increase direct and indirect tax revenue by enough to
cover the business tax revenue forgone through the EA concession.
EA schemes seem quite attractive compared to some alternative policies
for increasing sustainable employment and are thus to be preferred.
- EA schemes appear more cost effective than payroll tax cuts because
the former are targeted to impact at the margin and are less vulnerable
to offsetting wage increases.
- General wage subsidy schemes could not use the administrative capabilities
of the current business tax system as EA schemes do, especially in terms
of the tax system's comparatively high quality information base and
its considerable anti-abuse provisions and penalties for the supply
of incorrect information.
EA schemes may have a more benign (less polarising) effect on the distribution
of income than extensive labour market deregulation. Deregulation could
substantially reduce real wages at the bottom of the wage spectrum, unless
it was combined with redistributive tax/ transfer schemes such as an Earned
Income Tax Rebate.
There is a consensus that unemployment in Australia is far too high.
It is generating large social and psychological costs and represents an
enormous waste of the most valuable economic resource of all: human labour.
While considerable thought and public policy effort has been put into
measures to reduce unemployment, much of this has been hindered, perhaps
even halted, by substantial technical, institutional and political barriers
and by other policy priorities.
New thinking and new ways of approaching the problem appear to be called
for. One interesting proposal has existed in the economics literature
for some time but has been neglected in the policy arena so far (except
for one recent similar proposal). The proposal involves the use of one
type of tax incentive for increasing employment and reducing unemployment,
and is considered in a revised form in this paper.(1)
Specifically, the paper examines the usefulness of including an Employment
Allowance (EA) in the business taxation system in order to reduce effective
labour costs and, in turn, to increase labour demand and employment.
Such an allowance would comprise an additional tax deduction for employers,
over and above the existing 100 per cent tax deduction for labour costs,
based upon the employment of new (or better, additional) workers.
The specific example of an EA of 10 per cent of the costs of employing
new (extra) workers-a total tax deduction of 110 per cent of such costs-is
examined, as are the problems with this type of taxation scheme. Comparisons
are also made with other methods of encouraging higher employment, particularly
with other fiscal policy instruments, such as payroll tax cuts and general
wage subsidies, and with further and extensive labour market deregulation.
All costs (ie. financial outgoings) related to employment are already
fully tax deductible for employers. Under an EA, all costs relating to
the employment of new workers would attract an additional tax deduction
of, say, 10 per cent of those costs. Thus, wages, recruitment expenses,
formal and informal training expenses, employer superannuation contributions
and fringe benefit/ payroll tax payments incurred by employers in a financial
year for employees taken on within that financial year could all attract
the extra deduction for that financial year (and for some number of subsequent
years). The extra deduction is only available to businesses for extra
employment within Australia; businesses with overseas operations will
not be able to claim the extra EA deduction on those operations.
Little extra administrative and compliance expense would be incurred
by the employer in simple versions of an EA. Relatively few extra resources
of the Australian Tax Office (ATO) would need to be used to implement
such an EA itself since computer calculations will adjust tax liabilities
once the necessary information is fed in. A considerable amount of the
information needed for the EA is already collected in the current business
tax/ Superannuation Guarantee (SG) system.
However, more complicated and desirable versions of the EA would require
more information from businesses, would increase their decision-making
costs in using an EA, and would entail higher administrative costs for
the ATO. As well, it is difficult to judge the resources required for
the counter-measures needed to prevent abuse of an EA (which are discussed
later in this paper).
The aggregate unemployment rate is usually divided into cyclical (business
cycle) and non-cyclical (underlying) components. The latter is usually
called the Non Accelerating Inflation Rate of Unemployment (NAIRU) and
is the unemployment rate required to stop inflation from accelerating
on an enduring basis. The NAIRU abstracts from 'Keynesian' unemployment,
which occurs during recessions and is caused by insufficient demand for
goods and services, and focuses upon the more enduring, underlying sources
of unemployment.(2) A policy proposal can reduce unemployment on a sustainable
and enduring basis only if it reduces underlying unemployment (the NAIRU)
in some way, and so the components of that unemployment need to be considered.
First, frictional unemployment is always one component, and is generated
by workers remaining unemployed to search for better jobs and by employers
leaving jobs vacant to search for better workers to fill them. Workers
experiencing frictional unemployment may be new entrants to the labour
force or those who have moved to a new suburb, town or region.
Second, mismatch unemployment is usually a component of underlying unemployment
and is generated by mismatch between the skills, qualifications and geographical
location of the unemployed and those required by employers. These types
of unemployment are not generally amenable to reduction by an EA. As usually
conceived of, an EA is essentially about increasing the overall aggregate
demand for labour, while these two types of unemployment essentially require
measures to improve the effective supply of labour and the overall efficiency
of the labour market. However, it would be possible to design an EA which,
along with its general provisions to be described in the rest of this
paper, sought to raise labour demand for particular types of workers and
thus helped reduce mismatch unemployment.
Underlying unemployment can also be thought of as often containing a
third component, 'classical unemployment', brought about because real
(ie. inflation-adjusted) wages are too high in relation to the productivity
of workers at the margin of employment. An EA holds out good prospects
of reducing this type of unemployment because it can help to generate
the extra labour demand to match the existing and available labour supply.(3)
Currently, Australian unemployment seems to contain a large element of
classical unemployment, and thus it could be amenable to reduction through
policies such as an EA. For example, as perceived by employers, the problem
of long term unemployment is very largely one of the real labour costs
of these unemployed being substantially above their productivity contributions
to the business, at least in the short to medium term period after they
are initially hired.
Thus, there are strong and plausible grounds for arguing that the EA
could reduce underlying unemployment. It could do this by reducing the
level of effective Real Unit Labour Costs (RULC) for employers in the
economy.(4) Many econometric studies have shown that RULC does have strong
effects upon aggregate employment and unemployment.(5) The EA could directly
reduce RULC at the margin since, for any given levels of payments relating
to new workers made by employers, less tax would be payable because of
the higher deduction entailed in the EA. Thus, other things being equal,
an EA reduces the after-tax RULC for employers of employing new workers
and this encourages the employment of new workers.
However, other things may not be equal after the implementation of an
EA. One problem immediately springs to mind which could undermine the
effectiveness of an EA in reducing underlying unemployment. This relates
to the well-known problem of 'labour market substitution' in labour market
programs. Employers substitute new employees for old ones, thus qualifying
for the EA on the new workers and probably increasing profits without
actually increasing their total workforce. In the extreme case, aggregate
unemployment and its underlying component are unchanged but after-tax
profits are higher and total tax revenue lower because of the use of the
EA to reduce business tax burdens.
The degree of labour market substitution in this situation under an
EA would be determined by whether the EA covered the additional costs
of replacing old workers with new ones. Such costs relate to differences
in productivity between old and new staff as well as the costs of recruitment
and training for the new workers. Replacement is only profitable if it
more than covers these costs. It is possible to imagine businesses engaging
in collusion to abuse EA provisions. Businesses could exchange workers
of similar skills and experience (thus minimising the costs of taking
on such 'new' workers) and qualify for the EA on such 'new' workers, without
changing their employment patterns to any substantial degree.
If substitution were a substantial problem (as it probably would be)
then it would be possible to design an EA which avoided it. Thus, the
EA might only be available for net aggregate increases in employment by
the employer in the given financial year rather than being available for
the employment of all new workers in the financial year. For example,
if an employer hired 100 new employees during the year but also dismissed
40 existing employees then the EA could only be claimed for the net increase
in employment of 60 in that year. This converts the EA into a 'marginal
wage subsidy scheme'.(6)
Even in the extreme and unlikely situation that aggregate hours worked
for the employer are unchanged (so that average hours worked per employee
falls) this EA would have the beneficial effect of redistributing work
towards those previously unemployed.
Alternatively, only net employment increases above some benchmark rate
of growth for employment might attract the EA. If average employment by
businesses is expected to grow by X per cent in the coming year or over
the next few years because of the normal growth path of the economy, then
the EA might be designed so that it only applies to employment increases
over and above that X per cent. Here, new workers above the X per cent
threshold attract the EA for the first and some following years and are
then absorbed into the general normal employment expansion path of the
industry and economy, with the EA generating employment for a new set
of workers in the next year. In this way an EA holds out the prospect
of an outward and permanent jump in the aggregate labour demand and employment
path of the economy.
Such an EA would have the very useful advantage of encouraging structural
change and thus, in turn, encouraging higher productivity growth in the
economy. Businesses in industries expanding rapidly would easily meet
the X per cent employment growth requirement to qualify for the EA, and
the extra concessions of the EA would help them to grow even more quickly.
Labour resources would be encouraged to move into expanding industries.
Businesses in declining industries would generally not be able to meet
the X per cent employment growth requirement for the EA and would thus
not qualify for it.
Alternatively, the X per cent rule could be varied for each industry
so that all industries were effectively qualified for it. In this case,
the EA could encourage structural change within each industry by further
encouraging the most rapidly growing firms.
One major advantage of this restriction is that, by reducing the possibility
of abuse/ overclaiming through labour market substitution, it better targets
the tax concession on increasing aggregate employment and thus allows
the rate of the concession to be higher than it would otherwise be for
any given level of revenue forgone by the concession.
The direct tax system would seem to be the best administrative vehicle
for implementing an EA structured to have an aggregate employment qualifying
rule. This is because much information on employment is already supplied
by businesses to the ATO with their tax returns, especially in relation
to the requirements for satisfying the provisions of the Superannuation
Guarantee (SG) system, and it would thus be relatively easy for the Government
to implement the employment qualifying rule of the EA through the tax
system. It could also use the existing substantial penalty provisions
of the tax system in regard to the supply of incorrect information.
Abuse by 'New Businesses'
Any EA with aggregate employment qualifying rules would need to take
special care to prevent abuse by businesses seeking to use the EA for
the first time. In general, new (or young) businesses should be given
access to an EA because they will be major vehicles for employment growth
and will thus enhance the effectiveness of an EA. However, abuses could
thus occur.
For example, existing businesses could seek to abuse an EA by continually
changing their registered names and other paraphernalia to give the appearance
that they are 'new' businesses.(7) In principle, this would allow them
to claim the EA for their entire workforce since they will give the appearance
of having an entirely new workforce (ie. going from 0 to X number of workers
and thus qualifying for the EA on all of them) whereas in reality it may
be the case that no new workers have been employed. Such firms, with continually
changing names and identities (and Tax File Numbers), will clearly abuse
the EA scheme and waste the tax concession provided.(8)
EA guidelines would need to be put in place to eliminate such abuse.
They could, for example, only allow businesses to access the EA for the
first time if they could prove that they were genuinely new businesses
rather than existing businesses masquerading as new ones. The proprietors
of businesses seeking to access the EA for the first time could be required
to show that their businesses were different from those owned and operated
by proprietors who had already accessed the EA by having, say, a different
location of operations from previous businesses and with substantially
different workforces such as, say, a 50 per cent turnover in workers.
Such qualifying rules would seem to be both administratively feasible
and effective in preventing abuse, but would entail higher administrative
and compliance costs.
It should also be noted here that many new businesses will not be able
to have direct access to the EA in their first few years of operation
because they will be incurring operating losses rather than profits. However,
those losses will be carried forward as deductions to be used in the years
when the businesses begin to make profits, so that the extra EA deductions
relating to higher employment at the margin should also be able to be
carried forward to those latter years. In this case there may also be
a need to prevent the transfer of losses between related businesses which
include an EA amount so that the benefit remains with the employing firm.(9)
Alternatively, the EA might be made ' tax refundable' and thus in effect
be converted to marginal wage cash-payments for new businesses which need
some more immediate assistance to encourage their establishment and development.
That is, payments would be made to firms whose tax liability is already
zero. This action would be necessary to maximise the employment effects
of the scheme and to dampen complaints that an EA 'discriminated' against
new businesses. Making the EA refundable would be essential if the scheme
was to be extended to public sector agencies since the bulk of these organisations
are not a part of the direct tax system.
Loading the EA with High-Wage Workers
Another likely avenue for abuse and overclaiming would be for businesses
to seek to concentrate their high-wage workers in the positions subsidised
through the EA in order to reduce their tax burdens and their average
after-tax labour costs. Inflows and outflows of workers in the business
could be manipulated to put the highest waged workers into the EA-assisted
positions.
The obvious method for dealing with this problem is to reduce the EA
available for high waged workers compared to that for low waged workers,
and thus to remove the incentive for this type of substitution. As well,
a dollar limit might be placed on the value of the EA available for each
extra job created at the margin within the business. Indeed, the EA might
be so structured that it offers equal tax benefits for all extra workers,
regardless of the wage paid, so that businesses would receive no financial
gain from changing the workers whose wages receive the tax benefit.(10)
In terms of general anti-abuse provisions, an aggregate limit on the
dollar value of the EA tax relief available to each business might also
be useful/ necessary in containing overclaiming.
Breaking up Full-time Jobs into Part-time Jobs
Because the number of unemployed persons in Australia is far too large,
aggregate increases in employment by businesses would be rewarded by an
EA scheme. However, businesses are likely to abuse the EA by breaking
up full-time jobs into part-time ones, thereby increasing the total number
of persons employed while not necessarily increasing the aggregate hours
worked in the business at all. The constant amount of aggregate work time
would merely be spread over a larger number of people.
While such redistributions of work would be welcome to some extent for
equity reasons, if allowed to go unchecked this manipulation of the scheme
is very likely to make an EA scheme financially and politically unworkable.
One obvious way of preventing this manipulation is to specify a base
for the EA in terms of 'equivalent full-time jobs'. From the one or several
years preceding application for the EA, a base would be formed in which
part-time jobs would be converted into fractions of equivalent full-time
jobs. This will produce a number for equivalent full-time employment and
the EA would be only available on employment over and above this employment
base threshold. This method for calculating EA benefits takes away the
incentive to break up full-time jobs into part-time ones.
Probably the most serious set of problems which might undermine the
effectiveness of an EA in reducing underlying unemployment relates to
wages. The lower initial unemployment generated by the EA might provoke
generalised stronger wage pressures throughout the economy, and workers
and unions might take advantage of the tighter labour market to press
for higher wage growth. Indeed, after the introduction of an EA they might
push for higher wages without waiting for any improvement in the labour
market, so that the EA would be negated from its very inception. In either
case, the benefits of the EA would be passed backward to the existing
workers rather than retained by businesses to increase employment.
Such stronger wage pressures would either increase RULC towards its
pre-EA levels, thus negating the EA, and/or substantially increase the
growth rate of nominal wages (and thus inflation) so that restrictive
macroeconomic policy measures had to be implemented, again negating the
effects of an EA.
Pessimists might argue that such renewed wage pressures would be so
strong as to fully negate the beneficial effects of an EA on employment.
If so, underlying unemployment would not be reduced at all, in the long
run, by an EA. These arguments are also often made in relation to cutting
or abolishing payroll tax.(11)
The general point should be admitted here that schemes such as an EA
are most applicable to situations where employment/ unemployment is very
responsive to RULC but where RULC is in turn not very responsive to employment/
unemployment. An EA would not be very suitable to situations where the
reverse conditions hold. However, it can be argued that a well-designed
EA will be much more in the former category than the latter one.
For example, it can be persuasively argued that wage pressures would
only be a small partial offset so that underlying unemployment could be
sustainably reduced by an EA. Remember that in the case of classical unemployment
(where RULC at the margin is too high) an EA creates extra labour demand
for a labour supply that effectively already exists-ie. some of the unemployed
want to work at going market wages but are unable to find jobs. This balancing
of demand and supply does not seem to generate a situation of substantial
excess demand as assumed by the pessimistic analysts who seem to have
the cases of frictional and mismatch unemployment in their minds.(12)
The case of an EA of 10 per cent, analysed later in this paper, would
seem to generate moderate enough effects on employment so that wage pressures
were not a major problem.
It might also be noted here that cutting or abolishing payroll tax,
also a way of reducing RULC, would seem to be more vulnerable to these
problems of 'offsetting wage push' than an EA. The former measure applies
directly to a broader group of workers than the EA. For example, payroll
tax will apply to the entire workforce of many businesses. This broader
coverage would thus seem to make it more directly vulnerable to problems
of organised union wage push negating the tax change. Since an EA with
an employment qualifying rule by its very nature applies only to workers
at the margin of employment in most businesses, it is a much less visible
and more difficult target for organised wage push than are broad-based
policies such as changes to the payroll tax.(13)
In any event, it might be wise to incorporate some extra elements of
tax-based income policies (TBIP) in an EA scheme.(14) Under TBIP schemes,
businesses face higher tax rates when they allow nominal wage (or labour
cost) growth to exceed some threshold rate chosen to achieve some inflation
target. This acts as an disincentive to such growth in costs above the
threshold. It would thus be useful to an EA scheme in discouraging the
offsetting higher wage/ labour costs which could be argued to be generated
by the higher employment generated by the EA.
For example, the EA could be withdrawn from businesses which increase
their nominal unit wage/ labour costs (ie. money costs per unit of output)
by more than the specified threshold. However, if it proved necessary
to include them, such TBIP features would add somewhat to the administrative
complexity and information requirements of an EA, especially in regard
to the calculation of unit costs.
In a similar vein, it might be argued that an EA could be substantially
or wholly negated by the output price falls which may be required to sell
the extra output produced by higher employment levels. The benefits of
the EA would be passed forward to buyers of output rather than retained
by businesses to increase employment. Such price falls would tend to increase
RULC at the margin (since output prices are part of the denominator in
the calculation of RULC) and thus tend to bring them back to where they
were before the introduction of an EA.
In response, it should be noted that many prices in the Australian economy
are set on world markets, so extra output in such circumstances can be
sold without any fall in price received. That is, in these industries
output demand is very sensitive to price. In those industries and markets
where output demand is not very sensitive to price there will be no requirement
for price falls if demand can be increased in other ways. Thus, for example,
macroeconomic policy might be used to expand aggregate demand by a moderate
amount so that price falls are not necessary to sell the extra output
in these sectors.
Introducing an EA can be thought of as increasing the aggregate productive
capacity of the economy, so it is fitting that aggregate demand be expanded
through macroeconomic policy relaxation to match the increased capacity
to produce.
Any EA which is specified to have one simple aggregate employment qualifying
rule applying across the whole economy will necessarily subsidise employment
growth in some businesses in which growth would have taken place anyway.
In this sense, such an EA always has a 'deadweight waste' component, in
that it will not be as precisely targeted as would be desirable. It will
also mean that the EA is not available to encourage higher employment
growth in businesses which would otherwise have little (or even negative)
employment growth.
For example, for an EA which subsidises employment growth above say
2 per cent in all businesses, there will be a substantial number of prosperous
firms which would have increased their employment levels by more than
2 per cent without an EA. As well, the restriction would prevent access
to the EA by many firms in declining or static industries who could use
the EA to raise their employment.
If this problem of sloppy targeting looms too large, one obvious solution
is to vary the X per cent employment growth rule across industries in
order to reduce this waste component. Thus, industries with a strong existing
impetus for employment growth (eg. computer hardware and software) would
have their employment growth qualifying rule set at, say, X=4 per cent,
while industries in employment decline (eg. textiles and clothing) would
have their employment growth qualifying rule set at, say, X= -4 per cent.(15)
Such variations reduce the waste component of the EA by reducing its
coverage for employment growth which would have occurred anyway, and increase
the number of firms which can access it to take on workers which they
would otherwise not do. Businesses do this because they can utilise smaller
variations in employment growth within industries compared to sectoral
and national variations.
Indeed, the X per cent rule could be varied for each industry each year
on the basis of forecasts for employment growth for that industry. Employment
forecasts at the industry level are now regularly made by a range of private
and public sector organisations. The most accurate of these could be utilised
for setting the EA employment growth rule at the start of each financial
year for each industry. Thus, if the computer software industry is forecast
to increase aggregate employment by 5 per cent per business this coming
year then its EA rule could also be set at 5 per cent. Of course, it would
be important to ensure that the formulation of such forecasts was not
open to manipulation by the industries themselves.
New businesses pose additional problems of targeting for an EA. By their
nature, new businesses would be increasing their employment by more than
their industry's average growth. Allowing access to the EA for all employees
of new businesses is clearly very wasteful since the great bulk of these
would have been taken on without an EA. However, some sort of access to
the EA for new businesses is desirable to encourage even higher employment
by such firms.
Perhaps the most reasonable solution is to allow access to the EA only
when firms have reached some minimum employment size, with this minimum
to be chosen in relation to each industry's level of average employment
per firm.
The optimum length of time of EA subsidy is just long enough so that
the EA-assisted jobs continue to exist after the subsidy ends. Ongoing
human and physical capital accumulation will boost labour productivity
so that eventually these subsidised jobs will become profitable without
the benefit of the subsidy, so long as wage increases do not eat up all
of these improvements. Subsidised jobs will eventually 'stand on their
own feet' and at this point the EA subsidy can be withdrawn.
In order to minimise the time period for the EA it would be very useful
to freeze real wages for EA-subsidised jobs during the period that the
EA applies. This would seem fair since these jobs would not exist without
the EA in the first place. A reasonable quid pro quo for the EA would
be for the holders of such subsidised jobs to accept constant real wages
over the period in which the EA applies.
In terms of policy mechanisms to ensure that the real wages of such
jobs do not increase over the period in which the EA applies, the elements
of TBIP policies mentioned earlier could be used to help achieve this.
Businesses which allowed real wages to increase for EA-subsidised positions
could face withdrawal of the EA. More generally, they could face higher
overall tax rates on profits in this situation. As well, it would be very
useful for policy makers to communicate to the holders of such jobs that
the EA will only last for a certain period of time, after which they will
have to stand on their own feet and demonstrate to businesses that their
jobs are profitable to retain in their own right. This would strongly
encourage wage moderation by such job-holders.
It would also be wise to create special categories of EA-subsidised
workers for the purposes of enterprise bargaining processes and compliance
with the awards system. This would separate them from other workers, but
only for the period in which the EA applies, in order to insulate them
from general wage bargaining and real wage increases. Such separation
would only be temporary for each cohort of subsidised jobs. However, this
would require some major reforms to current and envisaged industrial relations
systems in Australia.
These policy measures to contain real wage increases for EA-subsidised
jobs might help to reduce the waste component entailed in the EA subsidising
jobs which would have been created in any event. For example, businesses
may wish to reduce the extent of their claims for the EA to minimise their
exposure to the chances of higher tax rates entailed by TBIP policies,
or the chances of losing the EA completely, due to too rapid wage increases
for EA-subsidised jobs. This would help to confine the EA to those jobs
actually dependent on the EA for their creation and ongoing existence.
An EA of 10 per cent: The Effects on Employment and the Budget
For an EA with an aggregate employment qualifying rule, the net cost
to the budget would depend on factors such as the rate of the concession,
the effective tax rate on business income (for both companies and unincorporated
businesses), the effectiveness of an EA in increasing aggregate employment,
and in the coverage and waste component of the EA. Offsetting factors
such as higher personal and business tax revenue and lower unemployment
benefit payments arising from the higher employment generated should also
be taken into account in assessing the total effect on the public sector's
budget balance.(16)
Many of these parameters are subject to considerable uncertainty, so
the calculation that follows must be viewed as only a very rough and approximate
depiction of the economic and budgetary effects of an EA.
Let us examine an average 10 per cent EA available to businesses and
public sector agencies on the costs of increasing their total employment
over employment levels in the previous year, measured in 'full-time equivalent
units'. There is an extra 10 per cent deduction, on average, for the costs
of employing extra workers, with the percentage varying across the range
of wage rates to give an average 10 per cent deduction. Here, the X per
cent qualifying rule is set at X=0 across the economy since average numbers
of employees per business has been roughly static in the last few years.
If this average had been increasing by, say, 1 per cent before the EA
then it would be reasonable to set the EA qualifying rule at 1 per cent.
As noted earlier, this is an economy-wide average; many businesses will
have employment growth below this benchmark of 0 per cent (ie. they will
be reducing their employment levels) and some new businesses will not
have yet reached the minimum size levels set for access to the EA. Such
firms thus do not qualify for the EA.
We have already noted that it is possible to design more complicated
EA schemes in which the benchmark employment growth qualification varies
across industries. Let us also assume a marginal rate of tax on business
income of 30 per cent (this is an average of the company and unincorporated
business sectors).
One crucial issue to be considered is the number of years for which
the EA concession on a specific batch of extra employees is to apply.
This needs to be long enough so that, by the end of the period, enough
physical and human capital accumulation has taken place to ensure that
those extra employees taken on due to the EA become absorbed into the
natural expansion path of employment of the industry and economy and will
not be retrenched once the EA for them ends. The EA concession for extra
employees probably needs to last at least two to three financial years
to ensure this. However, the length of this required period needs much
more empirical examination.
For prospective employees above the benchmark growth for employment
(in this EA, all extra employees) the 10 per cent EA with an average business
tax rate of 30 per cent would reduce RULC for such workers by about 3
per cent (.10 x .30 = .03). Now, if we assume a reasonable elasticity
(percentage magnitude) of response of say -0.70(17) for effects on aggregate
employment, then we can calculate that employment in those firms qualifying
for the EA will increase by about 2.1 per cent after this EA is introduced.
This responsiveness will probably be larger in the medium to long term
as there will be a stronger inducement to invest because such additional
productive capital will now be more profitable than before.
Since such firms will be only a portion of the total number of firms
the growth in national employment will be somewhat less than 2.1 per cent.
If such EA-eligible firms are 50 per cent of all firms then national employment
might increase by about 1 per cent (on top of the normal employment growth
in the economy) after the introduction of an EA.(18)
Clearly, any EA should be designed so that the percentage of firms eligible
for the concession should be as large as possible to maximise the employment
effects. This effect of EA eligibility rules on this percentage is of
vital importance and would require much closer empirical scrutiny. Our
assumption of 50 per cent access for this simple aggregate EA seems reasonable,
since it implies an approximately normal distribution about the known
average for employment growth.
For the purposes of further calculation let us assume that aggregate
employment increases by 1 per cent. In terms of current employment levels,
this 1 per cent increase resulting from the EA would amount to about 80,
000 extra jobs, spread across both the private and public sectors. This
is still quite an impressive result. Of course, a higher rate of EA would,
on these calculations, generate a proportionately higher gain in national
employment.
If we assume average labour costs of about $35, 000 per worker (the
approximate current private sector average across both full-time and part-time
workers), then this implies an extra labour cost bill of about $2.8 billion
(80,000 x 35,000). For a 10 per cent EA and an average business tax rate
of 30 per cent, this implies, in itself, a direct fall in business tax
revenue of about $85 million (2.8 billion x .10 x .30). If the EA applies
for three years this implies an annual revenue loss of about $250 million.
It was noted earlier that simple aggregate EAs such as this scheme have
an inherent component of 'waste' in the sense that it is inevitable that
the EA will be given for some employment growth which would have taken
place in any event. Many rapidly growing businesses will be increasing
their employment levels even without an EA. We need to add in this cost
to revenue in our calculations. This is a difficult area since we do not
have comprehensive data, for the economy as a whole, on firms changing
their employment in any year.
Let us make the reasonable assumption that such 'pre-existing' employment
growth in eligible businesses and public sector agencies-which would have
occurred anyway-will be about 5 per cent of total employment each year.(19)
This means that the direct cost to revenue of this illustrative EA scheme
would increase to about $1.5 billion per year ($250 million x 6).
In a full costing of this proposal it is also important to add in the
indirect gains to the Budget arising from an EA.
- First, total business profits will be higher as a result of the introduction
of an EA, thus tending to boost business net tax revenue in itself.
Let us assume that the ratio of wages to business profits (for companies
and unincorporated enterprises) in the national accounts remains constant
at about 2:1. Let us also assume that the $2.8 billion in labour costs
translates into about $2 billion in extra wages and salaries. This implies
that business profits would increase by about $1 billion and would generate
extra business tax revenue of about $ 300 million (1.0 x .30). Here,
we are including unincorporated enterprises with companies even though
the former actually pay their tax through the personal tax system.
- Second, personal income tax revenue will be higher. As above, let
us assume that about $2 billion in extra personal taxable income is
generated (for wage and salary earners). If we then assume an average
marginal personal tax rate of 25 per cent then an extra $500 million
in personal tax revenue is generated.
- Third, aggregate unemployment benefit payments will be lower. If we
assume that these 80, 000 extra jobs reduce the number of unemployment
benefit recipients by 50, 000 (the other 30, 000 jobs being taken by
non-recipients) and that the average annual unemployment benefit payment
is $8, 000, then the reduction in spending on unemployment benefits
is $400 million (50, 000 x 8, 000).
- As well, the rise in aggregate household income generated by the higher
employment will in turn generate some increase in consumption spending.
If allowed to go on, this will generate further rounds of income increases
and higher consumption and investment spending. All of this extra activity
will raise extra tax revenue through the indirect and direct tax systems.
Let us add in one round of tax raised from household consumption spending.
Assuming a marginal propensity to consume of 0.9 and an average indirect
tax rate of say 11 per cent, this will generate about $200 million in
extra revenue ($2 billion x .9 x .11).
However, this multiplier process assumes that there is some cyclical
slack (idle capacity) in the economy which can be whittled back. To the
extent that this is limited at the time of implementation of an EA then
these Keynesian processes will be restricted by counter-cyclical macroeconomic
policy designed to prevent the emergence of excess demand and accelerating
inflation. Although it was argued earlier that some expansion in aggregate
demand should accompany the introduction of an EA, aggregate demand should
not be expanded so much that excess demand and inflationary pressures
are also generated.
Overall, these calculations produce the somewhat surprising result that
the net impact on the Commonwealth Budget from the introduction of an
EA of 10 per cent could be close to zero, unless the waste factor is larger
than expected. Here, the EA would be very largely self-financing. If the
required length of time for the subsidy was two years rather than three,
then this EA would actually generate net revenue for the Commonwealth
Budget.(20)
However, if the 'waste element' of pre-existing employment growth in
eligible firms is substantially higher than expected, and the required
length of time for the subsidy was three years, then such an EA will very
likely generate a net move towards deficit in the Budget and extra financing
options will then need to be considered. On the other hand, for a required
subsidy time length of two years, a substantial waste element of say 10
per cent of total employment will generate a relatively small net revenue
loss of about $400 million.
Of course, it is also important to point out that these calculations
assume the most optimistic case of no offsetting factors which might tend
to push RULC back to its previous levels. Factors such as renewed real
wage push in response to lower unemployment or the wage and price effects
of indirect tax increases used to fund the EA, are discussed below. Reasonable
rates of business eligibility for the EA and a reasonable timelength to
convert EA-subsidised employees/ jobs into profitable ones are also assumed.
On the other hand, the use of eligibility rules that vary across industries
and employ good forecasting techniques for industry employment hold out
the prospect of substantially increasing the percentage of firms eligible
for the EA, and of considerably reducing the waste component of the EA.
This would increase the employment impact and reduce the budgetary costs
of an EA.
If the above example is at all plausible and realistic then an EA could
well be self-financing (and possibly generate net revenue for the budget)
and little further explicit consideration need be given to how it might
be financed. However, for the sake of completeness and in case the waste
component is large and some portion of an EA does need external financing,
let us consider how this financing issue affects our evaluation of an
EA.
In such a case, the prospects of an EA reducing unemployment will depend
upon the way in which an EA is financed. The various financing options
involve expenditure reductions, increases in direct taxes or indirect
taxes or some combination of these. There is also the option of larger
budget deficits and partial financing through higher public debt levels.
In regard to the options involving no permanent increase in the budget
deficit, it would seem that the effects of an EA in reducing unemployment
would be largest through financing by expenditure reductions and personal
tax increases, and somewhat less in the case of increases in indirect
taxes and company taxes.(21)
In the case of indirect taxes, there would be substantial offsetting
factors which would tend to push RULC back towards its original setting.
Nominal wages would tend to rise in consequence of the higher after-tax
prices of goods and services while prices in the hands of employers, their
after-tax receipts, would tend to fall somewhat as they bore some of the
burden of the higher indirect taxes.(22)
Both economic effects would tend to push RULC back towards its previous
levels. However, even in this case some substantial fall in unemployment
could still result if RULC was reduced in a permanent and sustainable
way.
In the cases of personal tax increases and spending cuts these offsetting
factors will be much smaller in magnitude, especially where classical
(real-wage based) unemployment is substantial. For example, wages do not
seem to be very responsive to changes in personal income tax rates (at
least in comparison to changes in indirect taxes) in the current Australian
situation where substantial unemployment exists.
Reliance upon personal tax increases to fund an EA would be much more
effective than reliance upon company tax increases because of the latter's
substantial impact upon employment and investment by companies.
Any short term effects on demand and output of any of these fiscal policy
packages could be accompanied by a monetary policy adjustment (eg. lower
official interest rates if the package dampens aggregate demand and economic
activity) to ensure robust aggregate demand, macroeconomic stability and
a smooth transition to the higher employment outcomes.
In 1993, in a submission to the Committee on Employment Opportunities,
Professor Richard Blandy put forward a plan for a marginal wage subsidy
scheme which has some similarities with the EA scheme examined here.(23)
As with the EA, the Blandy scheme proposed that the employment of additional
workers be subsidised so as to reduce the real unit costs of doing so,
in order to increase aggregate employment and thus reduce unemployment.
However, in contrast to the EA, Blandy proposed that
- such subsidies be explicitly financed through a special tax levy on
the earnings of existing workers,
- workers be given the choice of paying such taxes to the Federal Government
or to the business in which they work (Blandy predicted that the great
bulk of workers would choose to contribute such funds to their own firm),
- the entire costs of additional workers be subsidised so that such
workers become 'free resources' to businesses, and
- these subsidies be only temporarily utilised until aggregate unemployment
is reduced to some designated 'full employment' level, after which time
the subsidies will be scaled back and then abolished.
The Committee's Discussion Paper referred to the Blandy plan in only
one very brief endnote.(24) It argued that such a plan would only generate
a massive form of jobsharing in which businesses would substitute reduced
work hours of the existing employed for increased numbers of workers so
that aggregate work hours and output would change very little. This would
occur because the wage subsidy would not cover the costs of additional
materials and overheads; and these costs constraints would prevent any
substantial increase in aggregate production and work hours. The Committee
also pointed to problems of policing the requirement that these funds
be only spent by businesses on employing additional workers.
The Committee's critique of the scheme on dissipation through jobsharing
effects does seem true in one respect. As noted above with the EA, businesses
would resort to such substitutions unless restrained in some way. This
paper proposes that base levels of 'full-time equivalent employment' be
established for each business and that only employment above and beyond
this base be subsidised. Such a rule would also be useful in the case
of the Blandy scheme and would orient businesses towards increasing their
aggregate labour inputs into production.
However, the Committee's argument that costs of materials and overheads
might prevent increases in output and in aggregate work hours seems very
weak, especially under current economic circumstances. Businesses would
expand output and work hours if they expected it to be profitable, and
it is the purpose of marginal wage subsidy schemes to make it so. Once
extra profits are expected, businesses would finance 'working capital'
requirements of materials and overheads through the use of trade credit
and existing financial assets; thus, these costs do not seem to constitute
any substantial barrier to expansions in output and employment.
It is also very interesting to note that the Blandy plan's feature of
giving workers the choice of paying the levy to the Federal Government
or to their business of current employment would almost certainly mean
that at least part of the levy would be paid by employers and that this
would mean that something less than 100 per cent of the costs of employing
extra workers would be actually be financed by the jobs levy. Blandy argues,
quite persuasively, that this would come about because employers would
seek to entice their workers to lodge their jobs levy funds with them
by offering to pay part of the levy if they opted to keep such funds within
the business. This feature of his scheme makes it considerably closer
in nature to the operation of an EA scheme.
However, there are several remaining points of difference which indicate
that EA schemes are to be preferred to the Blandy scheme. First, under
the EA scheme policy makers have much more direct influence on the quantity
of new jobs created through their setting of the rate of the EA which
is to apply to each extra worker employed (eg. in the worked example analysed
above an EA of 10 per cent, on average across the wage spectrum). Under
the Blandy scheme, policy makers directly influence the quantity of funds
raised through their setting of the rate of the jobs levy, but they do
not seem to have any equivalent lever on the quantity of job creation
except for the rule that such funds must be used for the employment of
extra workers.
Blandy does include a proviso that each participating business is to
be compelled to increase its workforce by at least the increase which
would occur if all extra workers were taken on at average wage levels
for the business. However, he does not specify a mechanism for bringing
this about and seems to imply the use of very heavy-handed direct controls
and sanctions by the ATO to achieve the desired pattern of job creation.
In contrast, the EA provides incentives for the employment of substantial
numbers of extra workers, with the strongest incentives for employing
low-wage workers, without the need for direct controls.
Second, the Blandy scheme is founded upon a quite fixed, inflexible
funding source of proportional taxes on workers (and businesses). The
EA's reliance upon the general taxation system for funding allows scope
for much more diversified and progressive funding patterns. Of course,
for both schemes it needs to be mentioned that considerable financing
will be raised through the higher employment and national income which
can be generated by the schemes, so that any residual funding sources
might be a quite secondary issue of importance.
Third, Blandy himself argues that his scheme would do little to keep
the economy at full employment once it had arrived there since, in his
view, it would not generate ongoing increases in employment. The logic
of this argument seems rather obscure since he explicitly frames his scheme
as one which will come into use where necessary to stabilise the economy
at whatever rate of unemployment is regarded as full employment.
In any event, it could be argued that EA schemes will automatically
help to bolster employment, without the need for conscious adjustment
to do so as in the case of the Blandy scheme, because they will be always
present and acting at the margin to encourage businesses to increase their
employment levels.
Even an EA with an aggregate employment qualifying rule might have some
perverse and unintended effects if not further constrained by other rules.
For example, an EA could be viewed as giving more encouragement to the
employment of new workers on high wages than to those on low wages. An
EA of 10 per cent entails an extra tax deduction of 10 per cent for the
costs of employment of a new worker. Clearly, the extra deduction would
be far larger for a new worker on $50, 000 a year than for one on $20,
000 a year. Thus, the incentive provided to take on new workers (at least
in absolute dollar terms) would, other things being equal, be larger the
higher the wage of new workers.
This might seem to be the opposite of the incentive pattern which would
be recommended by distributional and social equity concerns.
On the other hand, the percentage reduction in labour costs arising
from a uniform EA will be the same for all workers across the wage spectrum.
It is usually argued that the percentage reduction will be the better
guide to enhanced incentives for higher employment of each wage category
of workers.
In any event, if this incentive structure of a uniform EA is considered
to be a major problem it might be avoided by setting the EA tax deduction
at a higher rate for low-wage new employees. The EA rate could be manipulated
so that it offered the same dollar value of tax relief for each worker,
regardless of wage levels. Alternatively, an absolute dollar limit on
the value of the extra EA deduction could used. Such weightings and limits
could skew the incentives to take on additional workers towards low-wage
employees.(25)
Both of these solutions were earlier canvassed as ways of combating
abuse of an EA through overclaiming, so they can serve two useful purposes
in the scheme. As with the aggregate employment qualifying rule, they
would add somewhat to the costs of administering the EA and would require
careful explanation to businesses so that the intended incentive effects
were clearly understood by them. However, the beneficial social equity
effects of encouraging more employment amongst low-wage workers would
be substantial and valuable.
If an EA with an aggregate employment qualifying rule has a positive
effect on the Budget outcome, then it will tend to have desirable anti-cyclical
effects during a recession. That is, during recessions when aggregate
employment falls the number of firms claiming the EA would fall dramatically,
thus reducing its impact on the Budget and tending to push the Budget
outcome towards deficit. This is exactly what would be needed and would
add to the strength of the other 'automatic fiscal policy stabilisers'
such as the general tax revenue system and the unemployment benefits system
operating to dampen the recession by bolstering private sector incomes.
However, an EA with a total employment qualifying rule which itself
moves the Budget outcome towards deficit could have perverse effects in
times of recession. During recessions employment growth throughout the
economy tends to fall and thus the number of firms meeting the qualifying
limit for the EA would again fall, thus reducing the total value of the
EA tax concession and the net revenue forgone. This would tend to push
the budget towards surplus at such times whereas automatic stabilisers
should act to move the budget towards deficit to help to dampen the recession.
In this case the problem might be avoided by deliberately increasing
the rate of the EA deduction (from, say, 10 per cent to 20 per cent) during
recessions to encourage employment and to help to dampen the recession,
and then dropping it back during times of economic recovery.(26) This
variation of EA rates might be desirable, on counter-cyclical grounds,
even in the case of EA schemes which improve the net budget balance.
The Federal Government and the ATO are currently in the midst of a project
to simplify the direct tax system to make it easier for taxpayers to understand
it and comply with it. The question could be raised as to whether an EA
would undermine this project by moving the business tax system back in
the direction of more complexity.
The answer to this question is a qualified yes, but the costs of greater
complexity would seem to be acceptable and tolerable if an EA could generate
substantial and sustainable increases in employment and reductions in
unemployment. In any event, the additional complexity would be minimised
if the existing administrative machinery such as the Superannuation Guarantee
compliance and matching system is used.
Overall, it would seem that an EA would complement many of the elements
of existing Active Labour Market Programs (ALMPs).(27) The latter are
essentially about improving labour market supply and overall labour market
efficiency by increasing the skills and attractiveness to employers of
the long-term unemployed (LTU). In contrast to an EA, labour market substitution
(ie. getting subsidised long-term unemployed in to jobs, even at the expense
of other workers) seems to be regarded as a more acceptable part of ALMPs.
An EA reduces labour costs, boosts labour demand and thus helps to bring
the ALMPs to successful fruition by helping to create permanent new jobs
for the unemployed who have been empowered and made 'job ready' by the
ALMPs.
It is also possible to conceive of an EA which included specific help
for the long-term unemployed. A higher rate of EA deduction could be allowed
for the long-term unemployed as an extra incentive to take such people
into employment (say 30 per cent compared to the standard EA rate of 10
per cent). This extra deduction could last for say 1 year, after which
the standard EA rate would apply. In this case the wage subsidy components
of current ALMPs could be abolished and replaced by this higher EA allowance
for employing the LTU.
Let us now compare an EA using an aggregate employment qualifying rule
with other means of encouraging employment, such as payroll tax cuts,
general wage subsidies and labour market deregulation.
It would seem that the EA is superior to payroll tax cuts since the
latter applies to both workers currently employed and those who would
be drawn into employment by such tax cuts, whereas the EA with an employment
qualifying rule is targeted specifically at additional workers at the
margin. As well, many small businesses are already exempt from payroll
tax because of the concessionary thresholds used by the state governments
in collecting payroll tax.
Thus, the EA would achieve more in terms of employment (at least in
the short to medium term) than the revenue equivalent payroll tax cut
because the EA is better targeted to impact at the margin of current employment
levels. Additionally, it would seem to be somewhat less vulnerable to
generalised wage push than the payroll tax cut option because of its tighter
focus and better targeting to influence behaviour at the margin.
In terms of general wage subsidy programs, it would be possible to design
a marginal subsidy program which was effectively equivalent to the EA
discussed above. However, it would seem that an EA would involve fewer
administrative, monitoring and compliance costs than a wage subsidy scheme
because the former would build upon the existing administrative structures
of the business tax/ SG system and could thus use this system's valuable
features of comparatively high quality data and substantial penalties
for abuse, avoidance and evasion.
On the other hand, reduced tax liabilities through an EA will lag actual
additional employment by at least one financial year because the business
tax system does not settle such liabilities until the following financial
year. Since the lag for cash payments would presumably be much less (possibly
just a few weeks or months) it could be argued that such payments will
have a quicker impact upon aggregate employment in the year or so after
introduction.
This issue turns on the farsightedness of the relevant businesses and
more empirical information is required for proper evaluation. Conversion
of the EA to explicit marginal wage cash payments for new businesses experiencing
operating losses by making the EA tax refundable, as was mentioned in
an earlier section, might be even more highly desirable for this very
reason.
Extensive labour market deregulation to increase competitive pressures
in the Australian labour market and thus to lower RULC would also be effective
in raising employment and lowering underlying unemployment. However, a
central problem here is that deregulation could contribute to income inequality
which is far greater than under the EA because of the increased wage inequality
that it generates. As well, it would probably, in and of itself, reduce
the level of real earnings of low wage and salary earners.
For these reasons this policy course would face very serious political
barriers and obstacles. It also raises philosophical questions about the
morality of squeezing those who are already at the bottom of the socioeconomic
ladder, and who have already suffered real income reductions in recent
years.
On the other hand, combining extensive labour market deregulation with
tax-transfer compensation schemes for low wage and salary earners to ensure
that their disposable incomes did not fall (or even to ensure that they
increase) in the process might be both technically and politically attractive.
For example, reduced market wage rates for low wage and salary earners
could be combined with an extensive Earned Income Tax Rebate (EITR) Scheme,
which actually made substantial cash payments to low wage workers.(28)
This policy package could be very attractive and useful in reducing unemployment
while not allowing any increase in inequality on the distribution of disposable
incomes.(29)
Indeed, such schemes could use the extra national income generated by
the rise in national employment and fall in unemployment to actually increase
the real disposable income levels of low wage and salary earners.
Sadly, it must be admitted that unusual schemes such as the EA would
face ingrained dislike from many political and ideological viewpoints.
There will be those who dislike, and feel uncomfortable about, this scheme's
use of the argument linking labour costs with employment and unemployment,
but who will feel much more positively about the interventionist nature
of an EA and its potential deployment in place of extensive labour market
deregulation. Others will be uncomfortable about this interventionist
nature of the scheme and thus will much prefer extensive labour market
deregulation, but will welcome the use of the argument linking employment
and unemployment outcomes to the labour costs facing business.
Thus, an EA scheme cuts across traditional political and ideological
categories and is likely to receive a 'lukewarm' reaction for this reason
alone, regardless of its inherent merits and faults. However, on the above
analysis, a well-designed EA holds out the prospect of being able both
to increase national employment and to reduce income inequality and poverty
levels, without reducing real wages. This characteristic makes it a very
attractive option.
The main problems of an EA revolve around the extra information and
anti-abuse measures (and possibly, measures to prevent dissipation through
wage increases) required to make such a scheme work effectively and efficiently.
There would also be transitional problems about the scheme's effectiveness
since businesses (and especially their managers in charge of employment
decisions) would only gradually learn that the EA scheme was available
to encourage extra employment at the margin.(30) The financial costs of
an advertising campaign, which would need to be initially extensive, to
publicise the scheme (especially to these crucial employment managers)
would need to be taken into account in considering its implementation.
Such schemes do not seem to have been implemented on any national scale
in the advanced world before now, so there would always be the danger
of some unanticipated fatal flaw arising which could not be adequately
dealt with without fundamentally altering the scheme. This is always the
case with policy innovations.
This EA scheme fits well with the 'conventional wisdom' of many economists
that the tax-transfer system should be used to address income distribution
issues rather than this being addressed directly through the wage-setting
mechanisms of the industrial relations/ awards system. The EA scheme does
this in a way which does not generate any disincentive to work, which
seems to be a central problem with many types of transfer payments, because
it operates through businesses to generate higher employment and more
jobs and not through direct payments to individuals and families as in
EITR schemes.
EITR schemes also address distributional issues through the tax-transfer
system but they suffer from problems of discouraging work effort for certain
wage classes of workers. These disincentive effects are much reduced (but
not eliminated) in universal EITR schemes which apply to all workers.
However, the latter types of EITR are, in consequence, very expensive
to the budget and are thus far more difficult to finance.
- Johnson, G.E. and Layard, P.R.G. 'The Natural Rate of Unemployment:
Explanation and Policy' in Orley Ashenfelter and Richard Layard (eds)
Handbook of Labour Economics, volume 2. Amsterdam: North Holland,
1986: 954-956; and Layard, Richard, Nickell, Stephen and Jackman, Richard.
Unemployment: Macroeconomic Performance and the Labour Market.
Oxford: Oxford University Press, 1991: 490-492. During the second half
of the 1970s Britain operated a marginal wage subsidy scheme for manufacturing
firms in depressed areas. Retrospective evaluation indicated that it
had a significant positive impact on employment in eligible firms: Layard,
Richard. 'The Costs and Benefits of Selective Employment Policies: the
British Case'. British Journal of Industrial Relations, 17(2),
1979: 193-194. The United States also operated a similar scheme, the
New Jobs Tax Credit Programme, at the same time: Haveman, Robert. 'Reducing
Poverty While Increasing Employment: A Primer on Alternative Strategies,
and a Blueprint'. OECD Economic Studies, no. 26, 1996/ 1: 37.
- Economic Planning and Advisory Commission (EPAC). Future Labour
Market Issues for Australia. Canberra: Australian Government Publishing
Service, July 1996: chapter 4.
- EPAC (Future Labour Market Issues for Australia. Canberra:
Australian Government Publishing Service, 1996: 60) uses the term 'structural
unemployment' to cover both mismatch and classical unemployment.
- RULC is calculated by adding nominal labour on-costs such as payroll
tax and superannuation contributions to nominal wages and salaries,
and then dividing first by some measure of output prices and then by
some measure of labour productivity.
- For the most recent results, see: Phipps, A.J. and Sheen, J.R. 'Macroeconomic
Policy and Employment Growth in Australia'. Australian Economic Review,
no. 109. 1st quarter, 1995: 86-104. Phipps and Sheen actually report
results for the effects on employment of real wages, and not RULC per
se.Other notable Australian studies which report statistically significant
effects for either real wages or RULC include: Russell, Bill and Tease,
Warren. 'Employment, Output and Real Wages'. Economic Record,
no. 196, March 1990: 34-45; Pissarides, Christopher. 'Real Wages and
Unemployment in Australia'. Economica, no. 229, February, 1991:
35-55; Ooi, Soon Huay and Groenewold, Nicolaas. 'The Causes of Unemployment
in Australia, 1966-1987'. Australian Economic Papers, no. 58,
June 1992: 77-93; Dao, Dan. 'A Model of Unemployment' in Committee on
Employment Opportunities. Restoring Full Employment. Canberra:
Australian Government Publishing Service, December 1993. Background
Papers: 155-162.
- Sloan, Judy and Wooden, Mark. 'Labour Market Programs' in Freebairn,
John, Porter, Michael and Walsh, Cliff (eds) Spending and Taxing:
Australian Reform Options. Sydney: Allen and Unwin, 1987: 152-153.
- I thank Bernard Pulle for pointing this out to me.
- Lindbeck, Assar. 'The Welfare State and the Employment Problem'.
American Economic Review (Papers and Proceedings), 84(2), May
1994: 74.
- I thank Chris Field for pointing this out to me.
- Fittoussi, Jean-Paul. 'Wage Distribution and Unemployment: the French
Experience'. American Economic Review (Papers and Proceedings),
84(2), May 1994: 63. The British scheme of the 1970s also used a flat
level of subsidy payment (see endnote 1 above).
- The important point should be noted that such long run analyses assume
away unemployment and any changes therein: Freebairn, John. 'The GST
and Payroll Tax Abolition' in John Head (ed) Fightback! An Economic
Assessment. Sydney: Australian Tax Research Foundation, 1993: 97.
- Indeed, there are a number of econometric studies on Australia which
report that unemployment levels have very little (or no) effect on nominal
and real wage outcomes. For example, see: Mitchell, William. 'The NAIRU,
Structural Imbalance and the Macroequilibrium Unemployment Rate'. Australian
Economic Papers, no. 48, June 1987: 101-118; Watts, Martin and Mitchell,
William. 'Australian Wage Inflation; Real Wage Resistance, Hysteresis
and Incomes Policy, 1968(3)-1988(3)'. The Manchester School,
58(2), June 1990: 142-164; Dawkins, Peter and Wooden, Mark. 'Labour
Utilisation and Wage Inflation in Australia: An Empirical Examination'
Economic Record, no. 173, June 1985: 516-521. However, there
are also a number of studies which find statistically significant effects:
Simes, R.M. and Richardson,C.J. 'Wage Determination in Australia'. Economic
Record, no. 181, June 1987:144-155; Ooi, Soon Huay and Groenewold,
Nicolaas. 'The Causes of Unemployment in Australia'. Australian Economic
Papers,. no. 58, June 1992: 85. Some of these studies would seem
to be suffering from a number of methodological flaws which cast doubt
over their results. For example, surely the relevant variable for regression
analysis of effects on wages is not unemployment per se but the deviation
of actual unemployment from the current NAIRU level with the latter
being able to vary over time. Only the 1987 Mitchell paper and the 1987
Simes and Richardson paper examine the issue in this way. The divergent
results of these two papers is somewhat mysterious; the first found
the deviation variable statistically significant but the second did
not, although the test was close in the latter and in both studies it
had the expected sign. These differences may be partly due to differences
in their (relatively crude in both cases) calculation of the NAIRU variable.
These empirical results are relevant in that we are arguing that an
EA can reduce both the NAIRU and actual unemployment without increasing
the deviation between them, rather than just increasing the deviation
by pushing unemployment temporarily below some predetermined NAIRU.
- In any event, it is interesting to note that there exists no Australian
statistical evidence to support the argument that the burden of the
payroll tax is borne by workers through lower real wages. Indeed, there
is statistical evidence to the contrary, albeit of only of a short run
nature, that it does not generate real wage adjustments: Ooi, Soon Huay
and Groenewold, Nicolaas. 'The Causes of Unemployment in Australia 1966-1987'.
Australian Economic Papers, no. 58, June 1992: equation 17; Lewis,
Philip and Kirby, Michael. 'The Impact of Incomes Policy on Aggregate
Wage Determination in Australia'. Economic Record, no. 181, June
1987: 159.
- Layard, Richard, Nickel, Stephen and Jackman, Richard. Unemployment:
Macroeconomic Performance and the Labour Market. Oxford: Oxford
University Press, 1991: 485-490.
- However, it could be argued that a universal lower limit of 0% job
growth should be set for the EA in order not to delay structural change
which is generating job losses in industries in 'natural decline'. I
thank Geoff Winter for pointing this out to me.
- Piggott, John and Chapman, Bruce. 'Costing the Job Compact'. Economic
Record, no. 215, December 1995: 313-328.
- Phipps, A.J. and Sheen, J.R. 'Macroeconomic Policy and Employment
Growth in Australia'. Australian Economic Review, no. 109, 1st
quarter, 1995: 95; and more generally, EPAC, Future Labour Market
Issues for Australia. Canberra: Australian Government Publishing
Service, July 1996: 17-18. A question can be validly raised as to whether
it is appropriate to use an elasticity estimated from data on general
averages for real wages and RULC in an examination of the effects of
changes in real wages and RULC at the margin only. Since the relevant
econometric studies control for the effects of many other variables
on employment and unemployment, we can be confident that the estimated
elasticities measure the effect of changes in real wages or RULC at
the margin, for other determining factors held constant. This is what
our calculation requires. As well, we know that it is changes in costs
at the margin which is needed, for other factors held constant, to affect
business behaviour. However, it is also clear that general changes in
averages for real wages and RULC will have larger long run total elasticities
of effect than for marginal changes when we add up all the channels
of influence. For example, general changes will have much larger effects
on total business profits than marginal changes, and this will feed
into stronger investment effects through the influence of financial/
cash flow constraints on business investment plans. A higher capital
stock will in turn encourage more employment.
- A reviewer has argued that account needs to be taken of the reduction
in employment by unsubsidised businesses as subsidised businesses use
the EA to reduce costs and prices and thus to take customers away from
the unsubsidised. However, this jobs transfer or 'displacement effect'
(which will very probably be small) does not seem to have any implications
for aggregate employment effects of an EA, precisely because it is just
a transfer between businesses and will be 'netted out' in terms of the
national economy. The employment effects in the worked example can be
thought of as net increases, over and above any displacement effect.
- This parameter requires very careful empirical study since it will
have a major effect on the financial viability of an EA scheme. Data
sources are limited but estimates for the manufacturing sector are available:
Borland, Jeff and Home, Richard. 'Establishment-Level Employment in
Manufacturing Industry: Is Small Really Beautiful?'. Australian Bulletin
of Labour, 20(2), June 1994: Table 1. Borland and Home estimate
that this job creation rate was about 16% over 1984-85. However, more
recent work by Borland for the period 1978-79 to 1991-92 shows an average
job creation rate for manufacturing of just 2.3%: Borland, Jeff. 'Job
Creation and Job Destruction in Manufacturing Industry in Australia'.
Economic Record, no. 216, March, 1996: Table 1. Now, if we adjust
for factors such as that the job creation rate would probably be lower
in the public sector, mining and agriculture, but probably higher in
the services sector, that national job creation and destruction rates
will be typically be lower now, and that various eligibility constraints
in an EA will reduce the deadweight loss factor (eg. minimum size rules
for eligibility of new businesses), it would seem reasonable to argue
that a waste factor of approximately 5% will be applicable. This estimate
is supported by recent calculations by the Industry Commission on rates
of aggregate job creation and destruction in Australia, using industry-level
data (rather than firm-level data): Industry Commission. 1995-96
Annual Report. Canberra: Australian Government Publishing Service:
Box 2.1, page 16.
- Similar fiscal results have been reported, on the basis of plausible
assumptions, in the case of policies to improve the 'job readiness'
of the long term unemployed: Piggott, John and Chapman, Bruce. 'Costing
the Job Compact'. Economic Record, no. 215, December 1995: 313-328.
For a contrary and critical perspective on such policies, see: Kenyon
Peter. 'The Job Compact: What Does the International Evidence on Active
Labour Market Policies Suggest about the Likelihood of its Success?'.
Australian Bulletin of Labour, 20(4). December 1994: 272-297.
- Chapman, Ross and Vincent, David. 'Payroll Taxes in Australia, Part
Two: An Economy-Wide Approach to Estimating the Effects of Their Removal'.
Economic Analysis and Policy, 17(2), September 1987: 149-177.
Chapman and Vincent's simulations using the ORANI model indicate that
a direct tax surcharge to fund the abolition of payroll tax will have
larger positive employment effects than funding through government spending
reductions, and still larger effects than for indirect tax increases.
However, in the case of government spending reductions they do not seem
to have modelled the possibility of combining this with some relaxation
of monetary policy in order to bolster aggregate demand. The latter
case would probably turn out to produce the largest employment effects
of all the scenarios. For a critical perspective on their results see:
Ryan, Mathew. What Future for Payroll Taxes in Australia? Canberra:
Treasury Research Paper. no. 10, September 1995.
- Freebairn, John. 'The GST and Payroll Tax Abolition' in John Head
(ed) Fightback! An Economic Assessment. Sydney: Australian Tax
Research Foundation, 1993: 106-108.
- Blandy, Richard. 'Submission to the Committee on Employment Opportunities',
October 1993. See also his article in The Australian, 13 October
1993. A good discussion of the Blandy scheme can also be found in Kenyon,
Peter. 'Restoring Full Employment: Backing an Outsider'. Australian
Economic Review, no. 105, 1st quarter, 1994: 43.
- Committee on Employment Opportunities. Restoring Full Employment:
A Discussion Paper. Canberra: Australian Government Publishing Service.
December, 1993: endnote 13, page 72.
- Alternatively, wage subsidy schemes exclusively targeted at low wage
earners have recently been proposed: Pencavel, John. 'British Unemployment:
Letter from America'. Economic Journal, no. 104, May 1994: 630-631;
Phelps, Edmund. 'Low-Wage Employment Subsidies versus the Welfare State'.
American Economic Review (Papers and Proceedings), 84(2), May
1994: 54-58.
- This counter-cyclical role for wage subsidies is also a central part
of the Blandy scheme.
- Active Labour Market Policies are those which actively seek to help
the unemployed to find jobs, as opposed to the passive alternative of
just paying unemployment benefits to them.
- Hanratty, Phil. 'Helping the Working Poor: An Earned Income Tax Rebate
for Australia?'. Parliament of Australia, Parliamentary Research Service,
Research Note, no. 17, November 1996.
- Alternatively, an EITR might be combined with an EA scheme because
these are complementary ways of raising the employment, after-tax incomes
and living standards of the working poor and the unemployed. For a relevant
discussion, see: Haveman, Robert. 'Reducing Poverty While Increasing
Employment: A Primer on Alternative Strategies, and a Blueprint', OECD
Economic Studies, no. 26 1996/1: 7-42.
- I thank Mark Wooden for pointing this out to me.
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