business activity, and can be sharply increased during expanding phases. Adjustment of the base requires careful administration, but will reduce the likelihood of windfall profits. Second, the full effect on profits is a macroeconomic as well as a microeconomic phenomenon. In all numerical calculations on the macroeconomic model, labor income always increases in response to the credit; profits increase only when the credit base is quite low, and only then under the more expansionary forms of government financing strategies. Finally, base adjustment of the program appears to be an easy, immediate, and effective method of changing the level of aggregate demand in the economy. The program deserves consideration on this basis alone. (5) Both employment and investment tax credits are intended to encourage intertemporal substitution of inputs rather than permanent substitution of one input for the other, that is, the credits are intended to encourage firms to increase current levels of employment and investment. There is considerable empirical evidence, however, that employment tax credits will be more effective in this regard than investment tax credits. In particular, employment adjusts to changes in prices at a much faster rate than capital, and this characteristic of employment will improve the performance of the employment tax credit as a short-run policy measure. Also, employment credits may stimulate employment of low income, marginally skilled workers who make up a disproportionate share of the unemployed. It will also stimulate employment in many areas of the economy where investment tax credits have little direct impact. (6) The cost to the Government of an employment tax credit will depend on labor market characteristics, the credit base, and the method selected to finance the credit. A number of our calculations, which use current U.S. tax parameters, reveals declines in the Government deficit in response to a ceteris paribus increase in the credit, that is, the credit-induced expansion of tax receipts and contraction of unemployment benefits more than offset the loss in tax revenue attributed to the program. BIBLIOGRAPHY Archibald, G. C. "On Regional Economic Policy in the United Kingdom," in Essays in Honour of Lord Robbins, Edited by M. Peston and B. Corry, pp. 22445. London: Weidenfeld and Nicholson, 1972. Barth, Michael C. "Universal Wage-Rate Subsidy: Benefits and Effects." In the Economics of Federal Subsidy Programs, Part 4, a Compendium of Papers, Joint Economic Committee, U.S. Congress, pp. 497-540, Washington, D.C.: U.S. Government Printing Office, 1972. Berndt, Ernst_R., Jonathan R. Kesselman, and Samuel H. Williamson. “Tax Credits for Employment Rather than Investment." Discussion Paper 297–75, Institute for Research on Poverty, University of Wisconsin, 1975. Berndt, Ernst R. "Tax Policy, Energy Demand and Economic Growth." Full Employment on a Small Planet, Mason Gaffney, Ed., Madison, University of Wisconsin Press, 1976. Bhagwati, Jagdish N. and V. K. Ramaswami. "Domestic Distortions, Tariffs, and the Theory of Optimum Subsidy." Journal of Political Economy, 71 (February 1963): 44–50. Borts, George H. "Criteria for the Evaluation of Regional Development Pro-, grams." In Regional Accounts for Policy Decisions, Edited by W. Z. Hirsch, pp. 183-218. Baltimore, MD: Johns Hopkins Press, 1966. Clark, C. Scott. "Labor Hoarding in Durable Goods Industries." American Economic Rev. 63 (December 1973): 811-24. Coen, R. M. and B. G. Hickman. "Constrained Joint Estimation of Factor Demand and Production Functions." Review of Economics and Statistics 52 (August 1970):287–300. Eisner, Robert. "Proposel for a Job Development Credit: A Tax Credit for Investment in Human Capital." Working Paper, July 14, 1975. Fethke, Gary C. and Samuel H. Williamson. "The effects of Employment Tax Frisch, Ragnar. "Price-Wage-Tax-Subsidy Policies as Instruments in Maintaining Hagen, Everett E. "An Economic Justification of Protectionism." Quarterly Hamermesh, Daniel S. Economic Aspects of Manpower Training Programs. Lexington, Mass.: Heath Lexington Books, 1971. Grossman, Herschel I. "The Cyclical Pattern of Unemployment and Wage Inflation." Economica, November, 1974, pp. 403-13. Javits, Jacob. "Statements on Introduced Bills and Joint Resolutions, S. 2632.” Senate, October 1, 1971. Congressional Record, 92nd. Congress, 1st Session, V. 117: 34431-34432. Kaldor, Nicholas. "Wage Subsidies as a Remedy for Unemployment." Journal of Political Economy 44 (December 1936): 721-742. Kesselman, Jonathan R. "Conditional Subsidies in Income Maintenance." Western Economic Journal 9 (March 1971): 1–20. Lind, Truls and Jan Serck-Hanssen. "Regional Subsidies on Labour and Capital." Swedish Journal of Economics 74 (March 1972): 68-83. Lucas, Robert E. and Leonard A. Rapping. "Real Wages, Employment, and Inflation." In Microeconomic Foundations of Employment and Inflation Theory. New York: W. W. Norton & Co., 1970. Nadiri, M. Ishaw and Sherwin Rosen. "Interrelated Factor Demand Function." American Economic Review 59 (September 1969): 457-471. Oi, Walter Y. "Labor as a Quasi-Fixed Factor." Journal of Political Economy. Vol. 70, 1962, pp. 538-555. Peacock, A. and John Williamson. "Consumption Taxes and Compensatory Finance." The Economic Journal, March 1967, pp. 27-47. Picou, Glenn C. and Roger N. Waud. "The Cost of Capital, the Desired Capital Stock, and a Variable Investment Tax Credit as a Stabilization Tool." Special Studies Paper No. 37, Division of Research and Statistics, Federal Reserve Board, Washington, D.C. November 16, 1973. Rosen, Sherwin and M. Ishaq Nadiri. "A Disequilibrium Model of Demand for Factors of Production." American Economic Review, Proc. (May 1974): 264-270. Tinsley, P. A. "A Variable Adjustment Model of Labor Demand." International Economic Review, 12:3 October 1971, pp. 482-509. 92-525 - 77-11 23 APPENDIX We present here the aggregate model used for our analysis. There are 16 equations which include 6 identities, 8 behavioral equations, and two equilibrium conditions. There are five parameters and nine qualitative restrictions. s employment tax credit rate, and b=unemployment benefit, per worker. Given these definitions, the model contains the following identities and behavioral equations. (a) Accounting Identities: (1) Y=C+I+G (2) Y, WL+(1-T) w+Ws (L-LB)+kI D Conventional assumptions are made regarding qualitative properties of the model. These are: the marginal propensity to consume disposable income is greater than zero and less than one; investment is a decreasing function of the interest rate and an increasing function of the investment tax credit rate; the marginal product of labor is positive and decreasing; labor supply increases with respect to the money wage and decreases with respect to the price level; and demand for money increases with respect to GNP and decreases with respect to the rate of interest. The condition can be summarized as (subscripts indicate partial derivatives): O<C°ya<1, I;<0, Ix>0, Fz>0, FLL<0, L>O, L,LO, M,>0, M¡<0. The first six statements in the model are identities which define aggregate demand, personal income, disposable income, taxable profit, tax receipts and government expenditures, respectively. Several explanatory comments are necessary. Personal income, Equation 2, is wage income plus after-tax business profits, where after-tax profits include employment and investment tax credits. Employment tax credits, Ws(L-LË), are granted on that portion of the wage bill which exceeds the prescribed base. An across-the-board credit on the entire work force occurs when Lв=0; and a credit on new workers only occurs when LB=L. The latter is termed a marginal employment tax credit. Intermediate cases occur with 0≤LB/L≤1. Disposable income, Equation 3, contains unemployment compensation, a transfer payment dependent on the difference between the exogenously defined full employment work force and the actual work force. Tax revenue, Equation 5, is personal and business income taxes net of employment and investment tax credits. Equation 6 defines the deficit (or surplus) as government expenditures plus transfers minus tax revenues. Equations 7, 8, and 9 specify consumption, investment, and government expenditures. Consumption varies with disposable income, while investment is assumed to respond to the interest rate and the investment tax credit. Two alternatives are offered as possibilities for explaining the behavior of government expenditure. The first, Equation 9a, assumes government expenditures are set independently of the credit. The second representation, Equation 9b, has government expenditures reduced by the loss in tax revenue associated with the credit. A third possibility, which is not listed but which receives some attention in Section 2.3, is to have income taxes adjusting upward to offset the cost of the employment tax credit. Equation 10 postulates real output as a function of variable labor and initial capital stock. With capital fixed in the short-run production function, gross investment has no immediate impact on real output.1 Labor demand, Equation 11, presumes competition in the labor market, diminishing marginal productivity of labor (FL), and includes the employment tax credit rate as a "shift" parameter: an increase in the credit rate increases labor demand for all eligible workers.2 Labor supply, Equation 12, depends on the money wage and the price level. Labor supply can be varied to take into account the relative awareness workers have concerning the impact of prices on purchasing power. If workers are completely unaware of the impact of changing prices, they have "money illusion." If, however, employment decisions are made on the basis of real purchasing power, then aggregate prices are just as important as money wages in affecting labor supply. Demand for money, Equation 14, depends on the level of income and the interest rate. Equations 15 and 16 are equilibrium conditions. Demand equals the exogenously determined supply of money, and the value of real output equals GNP. The variable base employment credit (VBEC) has a direct effect on several key variables in the model, and these direct effects can readily be stated. First, in Equation 11, an increase in the credit will reduce the wage cost to the firm for eligible workers and thereby initiate an increase in labor demand. Second, in Equation 2, an increase in the credit increases the after-tax-profits component of personal income and therefore consumption. Finally, in Equation 5, the credit reduces government revenue; and if Equation 9b is used, the credit also reduces government expenditure. While it is possible to postulate these direct effects, the complete response of these and other variables in the economy to an increase in a VBEC depends on the full interaction of labor, commodity, and financial markets. ! This seems to be a plausible and empirically defensible short-run assumption. The implication of this particular formulation will be considered when the investment tax credit is compared with an employment tax credit in Section 2.4. The likely impact of a wage reduction on short-run demand for labor is the most controversial aspect of the program. Needless to say, if labor demand is unresponsive to changes in the wage rate, an employment credit would have no effect. The response of the firm to the credit is considered by Berndt, Kesselman, and Williamson (1975). We discuss this question in Section 3. More specifically, the labor supply function has the property op Low+L,P. Classical supply occurs when 6-0, which implies Low-L,P. In this case, the supply of labor is determined by the real wage. In contrast, a complete "money illusion" occurs when Le, which implies L,-0. In this case, workers ignore the effects that aggregate prices have on purchasing power and vary their offer of labor services only in response to changes in the money wage. Intermediate cases occur for 0<<Lw. |