Congress has mistakenly abandoned a promising, non-inflationary unemployment-relief policy that encouraged businesses to keep employees on payroll.
Congress has mistakenly abandoned a promising, non-inflationary unemployment-relief policy that encouraged businesses to keep employees on payroll.
I t’s now a near consensus on both left and right (on Econ Twitter) that President Biden’s American Rescue Plan (ARP) helped make our bout of high inflation measurably worse. AEI’s Michael Strain, Marc Goldwein of the Committee for a Responsible Federal Budget, former Obama Council of Economic Advisers chair Jason Furman, and the Federal Reserve itself all think that the act added roughly two to four percentage points to our current inflation rate.
A big part of ARP was an extension of federal supplements to state unemployment benefits. According to a CBO letter to Senator Kyrsten Sinema (D., Ariz.), the extra $300 per week bonus unemployment amounts to $144 billion in 2021 outlays alone. Again, this is money we as a country decided to spend in order to essentially bribe people not to work. Only when this assistance started to fade away did we see the current strong recovery in labor markets begin.
Was there a better way? Could we have allocated resources in ARP that would have kept people working, boosted productivity, and avoided the problem of too much cash in household bank accounts chasing too few goods? It turns out there was one right under our noses, and Congress should be taking steps now to implement it automatically for the next downturn in the economy.
The Employee Retention Credit (ERC) was the brainchild of the Senate Finance Committee staff of Senator Ron Wyden (D., Ore.). They made it more complicated than it needed to be, but the basic structure is fairly straightforward. Employers facing a significant loss in business revenue during a high-unemployment calendar quarter could claim a refundable tax credit of 50 percent of each employee’s wages, up to $10,000 in wages paid for that employee that quarter (for a maximum credit of $5,000 per quarter, per worker, a figure that is roughly equivalent to what a worker receives in state unemployment benefits in a calendar quarter). The credit is claimed on the quarterly payroll and withholding-tax return filed with the IRS.
Suppose ABC Hair Salon employs Joan for $10,000 per quarter. They suffer a big drop in revenues, so ordinarily Joan would be laid off. Instead, they pay Joan her salary and get a $5,000 credit on their quarterly payroll and withholding-tax form. Essentially, ABC Hair Salon is splitting Joan’s salary obligation between themselves and their tax cut, right down the middle.
This approach has several advantages to traditional unemployment benefits. Joan doesn’t sever her relationship with her employer — for her, nothing changes on a day-to-day basis. ABC Hair Salon doesn’t lose a valued and experienced employee, an asset they might not be able to replicate once they get back on their feet. Instead of burdening state unemployment systems (which are clunky and hard for everyone to navigate), the subsidy to keep Joan employed is a small matter of routine payroll-company tax compliance.
From an economic perspective, Joan isn’t any better off than before, so there’s no extra cash pushing up her demand for goods and services (hence less inflation risk). ABC Hair Salon also isn’t really any better off, since they are theoretically passing their payroll-tax cut right along to Joan. The taxpayer is left holding the bag, but that’s true with unemployment benefits, too.
Unfortunately, Congress canceled the final quarter of ERC benefits to help pay for the compromise infrastructure bill. In so doing, they pulled the rug out from employers in the fourth quarter of 2021. Representative Carol Miller (R., W.V.) has introduced H.R. 6161, the Employee Retention Tax Credit Reinstatement Act, to correct this injustice, which left tens of thousands of employers dealing with yet another broken promise out of Washington.
Going forward, Congress should put the ERC into law as a permanent alternative to old-fashioned unemployment benefits. An employer would qualify if it is located in a high-unemployment area and business receipts are down significantly since the prior year’s equivalent quarter. The tax credit against federal FICA and withholding taxes should be an amount that mimics unemployment-benefit amounts (50 percent of the first $10,000 in wages per employee per quarter ought to do it). An employer would exit credit eligibility when the unemployment rate and business revenues got back down to more normal levels.
The unemployment system would always be there as a backdrop, but an ERC competing with unemployment benefits means there is far less strain on the traditional system. The relationship between the worker and the employer is never severed, so labor shortages like those we are seeing now in the leisure and hospitality sectors would be much less pronounced. Companies that need to do layoffs still would — the ERC would be attractive only to those firms that need temporary tax relief, not a wholesale restructuring of their business model. Best of all, the ERC has the least inflationary impact on the economy.