How Payroll-Tax Holiday Affects Small Businesses

Matthew Bandyk

Signs of economic recovery might be appearing, but for the most part, small businesses are not seeing them.

The National Federation of Independent Business's Index of Small Business Optimism -- which measures small-business owners' sentiment about the economy -- fell 1.3 points in February. It was just 7 points higher than the lowest-ever level, recorded in March 2009. Washington is trying to change the mood with a new tax incentive aimed directly at small businesses. A tax credit "to go to over 1 million small businesses who hire new workers" was President Obama's big promise to Main Street in his State of the Union address, and a similar proposal recently reached Obama's desk in the form of the Hiring Incentives to Restore Employment Act.

Supporters in Congress claim that the bill will create hundreds of thousands of jobs by making it cheaper for businesses to add new employees. The good news is that small businesses may be more likely than larger businesses to use the incentives in the bill to add jobs that would not have otherwise been created. The bad news is that not many small businesses will find the jobs bill's incentives appealing in the first place.

The tax component of the bill is simple.

Employers currently pay Social Security taxes at 6.2 percent of each worker's wages. Social Security taxes are not levied on wages over $106,800. The bill offers a "tax holiday": Employers get out of paying the tax for the rest of the year for each unemployed worker they hire at a salary under $106,800. To qualify as unemployed under the terms of the bill, the employee must have been out of work for at least 60 days before being hired. If new employees stay at the job for at least 52 weeks, employers can cash in a $1,000 tax credit on their 2011 tax return.

The number of jobs that these incentives will create is in dispute.

The Congressional Budget Office analyzed a similar policy idea that would give a one-year payroll-tax holiday to employers that expand their payroll from 2009 to 2010. The CBO reports that this policy would add eight to 18 jobs for every $1 million spent on tax breaks. Since the tax portion of the jobs bill costs $13 billion, some analysts have been reported as saying that the bill will create between 104,000 and 234,000 jobs.

But the policy analyzed by the CBO ties the tax holiday to payrolls. An employer must hire more people in 2010 than it did in 2009 in order to receive the tax break. But with the tax holiday passed by Congress, it's all about the employment status of the worker. If the worker has not been unemployed for an extended period, then the business has no extra incentive to hire that worker.

That restriction could limit the number of businesses able or willing to cash in on the tax holiday. "Most people, when they go out and hire somebody, they hire the best person they can get," says Cap Willey, managing director of CBIZ Tofias, a New England accounting firm that works with many small businesses. "One of the last things they will think about is whether or not that person is employed."

Even if a business owner can find a job candidate who has been unemployed for 60 days or more, the economy is still weak enough that many businesses will not be able to afford to take on more employees, tax break or not. In a recent video released by the National Federation of Independent Business, several business owners who are members of the group expressed skepticism about a payroll-tax holiday. "I have to have sales in order to generate income that would allow me to hire somebody else, so a tax credit doesn't do me any good at all," says John Raney, owner of the Texas Aggieland Bookstore in College Station, Texas.

"Basically, it's not going to work for me, because until I have a customer base that's coming into the restaurant, I don't need to hire new people," says Karen Oertel, owner of the Harris Crab House restaurant in Grasonville, Md. According to the NFIB's most recent survey, only 4 percent of firms report that now is a good time to expand, compared with 3 percent the same time last year. The survey also finds a net decrease in the number of businesses planning to add jobs. One percent of firms report that they plan to decrease hiring in the next three months, compared with 3 percent last year.

Michael Ettlinger, vice president for economic policy at the Center for American Progress, argues that while a tax break might not persuade most businesses to take on new employees, some will be right on the edge of being able to afford to hire a new person. The jobs bill will provide that extra push to make hiring possible. But "that's only going to be at the margins. There will be very few businesses that are right at that tipping point," he says.

The businesses at that tipping point might be more likely to be smaller firms with a handful of employees, as opposed to larger corporations. "I would expect small employers to be more likely to be affected by this because of their flexibility," says Ettlinger. Small businesses can easily recognize their basic hiring abilities. "In the case of a large employer, they have a longer planning horizon on expanding employment. They don't expand or contract their workforce as quickly," says Ettlinger.

But these small businesses on the margins will not be the typical companies that benefit from the jobs bill. Instead, businesses that are already capitalized enough to hire -- and would have done so this year anyway -- will get an extra windfall. "There are millions of jobs being lost and created every month," says Ettlinger. "As a matter of basic arithmetic, most of the money will go to hires that would have happened anyway."

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How Payroll-Tax Holiday Affects Small Businesses