Disadvantages Of Ertc

The employee retention tax credit (ERTC) is the most economically efficient means of reducing the rate of employer turnover in the United States and is estimated to reduce federal tax liability for U.S. businesses by billions of dollars each year. In this paper, we outline a series of reasons why the ERTC should not be extended as it is scheduled to expire in 2015. In order to better understand the ERTC, a simplified analysis of the relationship between worker tenure and firm performance can be created.

Introduction

The Employee Retention Tax Credit (ERTC) is an employer-funded program aimed at improving job tenure. The ETC is scheduled to expire in 2015 and is typically reauthorized each year in the federal budget. While the ETC is widely celebrated in Washington, D.C., it receives little, if any, discussion in the business community, despite its strong economic benefits for firms and for the overall economy. In this paper, we explain why an ERC extension should not occur. We argue that the ERC benefits workers, while imposing significant costs on employers. Moreover, we outline specific considerations that need to be considered in analyzing the ERC before its expiration on September 30, 2022.

Increasing Worker Tenure

The ERTC is not a per-employee tax credit, but is instead funded by a payroll tax (a 1.45% of total payroll) paid by employers to employees as part of their employment tax. Currently, the maximum ETC is $3,000 per employee and the credit applies to the first $15,000 of wages earned. During a worker’s tenure with an employer, the ETC reduces the employee’s taxable income for the year. Thus, an employee who has been with a firm for at least four years pays no federal income tax on the $15,000 of wages earned. The ETC is therefore a tax reduction incentive that reduces the employee’s taxable income, without any effect on the employee’s net income or the firm’s profits.

The ERTC raises workers’ bargaining power, in that firms now have to pay higher wages in order to retain their workers. For example, a firm with 100 employees would have to pay $75,000 in federal income tax to replace each employee. Under the current tax system, this tax bill would be very expensive for the firm. On average, each worker’s salary is approximately $75,000. Thus, hiring a worker at $75,000 instead of $70,000 would have a significant impact on the firm’s profitability.

If the firm pays its employees about $95,000, for example, this increase in wages to maintain or increase workers’ tenure reduces the firm’s payroll tax bill by an average of about $10,000. Therefore, as long as the firm could afford to pay the $95,000 salary to maintain or increase workers’ tenure, it could afford to pay $75,000 in taxes, even though it would have otherwise paid the full $95,000. In other words, the cost of the tax increase is largely compensated by reduced payroll taxes. Thus, firms can now afford to pay workers more, if they so choose.

Job Tenure Effects on Firm Performance

As employers are spending more on wages to retain workers, it is likely that they have more money to invest in productive equipment and other assets. Indeed, firms are likely to invest more if they are not also paying higher income taxes on the increasing wages they are paying. Thus, the increased worker tenure reduces the amount of productive capital (e.g., plant and equipment and machinery) that firms are investing, in the same way that any tax cut for individuals (or a tax cut for firms) reduces the amount of capital they are able to invest. A reduction in the relative tax burdens on employees and the tax rates on productive assets (e.g., plant and equipment) have a large and significant positive economic effect.

Hence, firms may increase the capital invested in their firms, which improves firm performance and leads to increased consumption and increases growth. The other effect of a firm’s increased investment in capital is increased output, which increases demand for additional production. A firm with more capital invested has greater room to produce more goods. In this case, a firm’s increased investment in capital will increase the firm’s demand for workers, who in turn will increase the output of goods that firm can produce. Thus, a firm’s increased investment in capital in turn raises the output of goods.

Hence, the greater demand for workers that results from the higher wages a firm is paying also increases the workers’ demand for the goods they produce. This greater demand results in increased demand for goods, which increases employment. Thus, the improved firm performance, which increases worker tenure and their wages, reduces the unemployment rate. To give another example, if the productivity of the workers goes up, which is a result of the higher wages that they are paid, a firm can hire more workers and can therefore pay more than one worker the same amount of money as before.

Note that many things in the economy affect firm performance, but wage demands have the largest effect. ERC projects that a 10 percent increase in the relative wage of workers raises the firm’s labor productivity by 2 percent. Thus, a 10 percent wage increase results in a 1.5 percent increase in firm output, and a 10 percent wage increase results in an increase in output that is roughly 1.5 percent larger. An increase in the relative wage of workers is roughly the same as a 1.5 percent increase in the size of the economy, or to put it another way, a 1.5 percent increase in the relative wage of workers is roughly equivalent to a 1.5 percent increase in the nation’s GDP.

Disadvantages of Employee Retention Tax Credit

Let’s discuss the disadvantages of the Employee Retention Tax Credit.

  • An employee tax credit for retaining employees is not without its problems, however. First, firms will take advantage of the tax credit when the higher wages are needed and the only alternative to pay raises is to lay off workers. Therefore, some of the benefit of the tax credit will go to employers rather than to the workers. The workers will have the higher pay, but the employer is likely to save the rest. The system works well when the only alternatives are to hire workers or fire them. However, if the only alternative to an increase in the relative wage of workers is to hire fewer workers, then the tax credit is likely to be a less efficient way to encourage firm hiring. The tax credit may be more efficient than a raise in the relative wage of workers, but it is not necessarily the most efficient means to reduce the number of workers laid off.
  • Second, the tax credit would only reward firms that retain their existing employees rather than those who hire new workers. The tax credit would not necessarily encourage firms to increase the number of workers on their payrolls. Given the high fixed costs of hiring and training new workers, the number of workers a firm employs is a better measure of the firm’s investment in capital than its hiring of workers. If a firm only hires new workers when their firm needs to add workers, the tax credit is a useless encouragement.
  • Third, there is little economic evidence that firm’s that increase their wages actually increase employment. A tax credit, which would encourage firms to increase their wages, would increase employment at the expense of other firms.
  • Fourth, some firms could use the tax credit to force workers to leave. If firms know they are going to get a tax credit for keeping their current workers rather than replacing them with new workers, then they may be more likely to try to lure away their workers by offering them higher wages. If the firm hires fewer workers but pays them more than their previous jobs, then the workers would be able to demand a higher wage from the firm.
  • Fifth, the tax credit is less efficient than simply increasing the relative wage of workers. If firms do not increase the relative wages of their workers, then the tax credit will not be an effective incentive. Because the tax credit is for keeping existing employees, it is likely to be ineffective.
  • Sixth, the tax credit has no control over the relative wage of other workers. While it is true that firms that increase their workers’ relative wages receive a benefit from the tax credit, that is not true of other firms. If another firm or a worker’s self-help agency had lowered the relative wage of a worker, then the workers would receive a benefit from the tax credit even if they did not get a benefit from increasing their relative wages.
  • Finally, there is little evidence that the tax credit actually increases employment. There is not a firm that I am aware of that has gone out of business because it increased its wages, but there are quite a few that went out of business after increasing wages to meet their increased payroll costs. Perhaps the case that the tax credit is inefficient is due to a bias against raising wages in tight labor markets rather than due to a failure to increase firm employment, but it is certainly plausible.

As a solution to the incentive problem, the tax credit would have to have some of the following characteristics:

While there are some disadvantages to the tax credit, its benefits can also outweigh its disadvantages.

Conclusion

While there are some drawbacks to the Employee Retention Tax Credit, there are also benefits. First, as we mentioned earlier, the tax credit should have greater value than a raise in the relative wage of workers. In that case, employers are going to find a way to increase the relative wage of their workers. It is not possible to raise the relative wage of workers by making firms pay the workers more, but it is possible to raise the relative wage of workers by increasing the relative wage of other workers. The tax credit can be one way of providing a wage subsidy that provides an effective wage subsidy to workers, which can give a significant boost to economic growth.

The tax credit does have some disadvantages. First, the tax credit is an inefficient way to encourage firms to hire new workers and to retain existing workers. Second, the tax credit is an inefficient way to encourage firms to increase the relative wages of workers. If firms pay workers higher wages, workers will demand higher wages from other workers, which will force a reduction in the relative wage of workers that firms are paying. Third, the tax credit is an Inefficient way to provide wage subsidies. If firms hire workers, workers can demand higher wages from other workers, which will force a reduction in the relative wages of other workers.

These disadvantages can be mitigated. First, a tax credit is more efficient than simply increasing the relative wage of workers. If firms increase the relative wages of their workers, then they will receive a benefit from the tax credit even if they did not receive a benefit from increasing their relative wages. Second, the tax credit can be more efficient than simply increasing the relative wage of workers. Firms that pay higher wages receive a benefit from the tax credit even if they did not receive a benefit from increasing their relative wages. For example, if a firm pays higher wages, then the workers will be able to demand a higher wage from other workers, and that higher wage will give a firm that receives the benefit of the higher relative wage a higher profit.

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