The Irish Independent reports that the Financial Regulator has been severely criticised in an unpublished report it commissioned itself on how it operates.
Almost a year after the near collapse of the Irish banking system, the report is a damning indictment of how the regulator works.
The study -- seen by the Irish Independent -- says the regulator offers poor value for money.
The unpublished report has found that it has a low level of specialist regulatory staff compared with its peers.
Carried out by consultancy firm Mazars, the report also found that the Financial Regulator carries out fewer consumer inspections and initiates fewer enforcements than other EU regulators.
Marked "strictly confidential and not for publication", it also found that there were too few resources dedicated to prudential supervision.
However, in contrast to the lack of numbers working in specialist regulatory areas and in prudential supervision, the study found the regulator had too many administrative staff.
The role and duties of the senior managers in the regulator's office, and the way they relate to the board of the Financial Regulator, is unclear, the report says.
"There is an over-emphasis on internal management rather than reporting of core prudential, policy, market or outward-facing activities," the report says. Executives of the regulator put too much emphasis on the finances of the organisation instead of concentrating on strategic or regulatory matters.
"International benchmarking would suggest that the Financial Regulator employs lower levels of specialist regulatory support skills than its leading international peers," Mazars concluded.
The organisation also emerges as one of the most expensive in the West at delivering financial regulation.
The cost of providing regulation per employee comes in at €144,000 -- the third highest out of 16 different regulators looked at in the report.
On average, the costs of delivering regulation are €117,000 per employee in the 16 international regulatory bodies examined.
However, the costs to regulated entities are lower in Ireland than in other countries because 50pc of the regulator's funding, or €30m a year, comes from the State.
Most other international regulators are funded through levies on industry players. Mazars' point about the €30m provided by the State for regulation implies that taxpayers are picking up a higher tab than they should be.
The report says that there should be a reduction of between 30pc and 35pc over three years in the resources allocated to administrative support. "Support costs at 43pc are higher in Ireland than the international average (35pc)," the report states.
But overall, it says the total number of staff should remain the same.
Some 47pc of the resources of the regulator go on direct pay, with pension costs accounting for another 7pc of resources. This means that more than half of its funding is to pay salaries and pensions of its staff.
Mazars added: "Based on a small sample, Ireland has a lower number of consumer inspections and enforcement cases concluded per staff FTE (full-time equivalent) than its peers."
A spokeswoman for the regulator said that many of the report's recommendations have either been put in place or are about to be.
She emphasised that the Mazars report was commissioned by the regulator, and signed off on last February.
Asked why it had not been published, she said it was an internal report but had been forwarded to the Department of Finance.
The Irish Independent also reports that isolated Ceann Comhairle John O'Donoghue will resign next week after being forced out of office over revelations about his lavish expenses.
In a terse one-line statement, Mr O'Donoghue announced that he would resign his position next week when he will make a statement to the House.
His late-night announcement came after a day of high drama in the Dail which left him facing a vote of no-confidence.
Mr O'Donoghue told the Labour Party he was going to resign at 2.30pm next Tuesday.
Labour, which had slapped down the motion of no-confidence in the chair of the Dail, accepted the offer.
The choice of next week would allow Mr O'Donoghue to be returned automatically to the next Dail, should Green Party malcontents pull the plug on the Government at a special meeting on Saturday.
If the Greens opt to continue in coalition, it will be Mr O'Donoghue's replacement who will be returned automatically.
But he is still expected to enjoy a severance package of up to €90,000 over the next two years.
Last night there was no indication whether Mr O'Donoghue (53) intends to contest the next election, although he has shown no sign of resigning his Kerry South seat to force a by-election.
Labour leader Eamon Gilmore had substantially escalated the pressure by telling Mr O'Donoghue his position was no longer tenable and putting forward a motion of no-confidence.
Mr Gilmore stunned the chamber into silence by telling the Ceann Comhairle that he had to go. As Mr O'Donoghue sat motionless, the Labour leader said: "A Cheann Comhairle, I regret to say this, but I consider that your position is no longer tenable.
"I think you will either have to resign or be removed from office."
A chastened Ceann Comhairle could only manage: "Thank you, deputy Gilmore."
Fine Gael leader Enda Kenny later followed suit by calling on Mr O'Donoghue to resign. The Ceann Comhairle was understood to have then made arrangements for his departure, including informing his family of his decision.
Within Fianna Fail, there had been no appetite to rally around Mr O'Donoghue's cause. Likewise, the Green Party was in no mood to back the Ceann Comhairle.
Mr Cowen had asked the Green Party three times if they could support Mr O'Donoghue in a motion of no-confidence.
While Mr Gormley was not going after Mr O'Donoghue's head, he told Mr Cowen his party could not back the Ceann Comhairle.
Mr Cowen had three talks with Mr Gormley: once in the Green leader's office; once in the Taoiseach's office; and once on the phone from Mr Gormley's house.
"On each occasion John Gormley said they could not vote confidence in Mr O'Donoghue," a spokesman for the Green Party said.
Finance Minister Brian Lenihan earlier told the Fianna Fail parliamentary party that Mr O'Donoghue should be allowed natural justice.
Mr O'Donoghue is expected to receive a severance package of up to €90,000 over the next two years. It would compensate him for dropping from a salary of €225,000, as Ceann Comhairle, to €100,000, as a TD, although the Department of Finance could not provide a figure last night.
He will also be entitled to a ministerial pension while sitting on the government backbenches, although its value will be cut by 25pc due to changes introduced this year.
Mr Cowen noticeably failed to declare that he had confidence in Mr O'Donoghue when pressed on the issue in the Dail yesterday. He merely insisted that the most appropriate forum to deal with the issue was the Houses of the Oireachtas Commission.
Mr Gilmore's dramatic Dail move forced Mr Kenny to hastily rush out and also demand Mr O'Donoghue's resignation.
But he denied that he had lacked courage in failing to raise the issue in the Dail, saying he had made his position clear on Sunday night and that he believed in giving people time to have their say.
"I felt it fair that he should have the opportunity to go before the commission. Circumstances have changed since then," Mr Kenny said.
The Irish Times reports that the Irish economy is “over the worst” and is now “bubbling along at the bottom”, the assistant director general of the Central Bank Tom O’Connell said when introducing the bank’s latest quarterly bulletin yesterday.
The bank estimates that gross domestic product (GDP) will fall by 7.8 per cent this year and by a further 2.3 per cent next year. This compares with its forecasts of 8.3 per cent and 2.7 per cent respectively in its July bulletin.
“The fallout from the unwinding of the large domestic imbalances created during the earlier boom will continue to constrain economic activity and significant headwinds to recovery remain in place,” the bulletin said.
The bank says its outlook is based on a presumption of growth in our main trading partners. It says domestic growth, when it returns in 2011, is likely to be modest, with domestic demand likely to remain weak.
With a presumption of outward migration and a fall in labour force participation, the bank expects unemployment to average more than 14 per cent during 2010.
The high level of unemployment is likely to cause a fall in wage rates in the private sector, leading to a partial reversal of the loss of competitiveness that occurred over recent years.
Output in 2010 is likely to be 14 per cent below that of 2007. “That is the full extent of the hit we have taken, if you like,” Mr O’Connell said.
The bulletin said the policy requirements to deal with the economic challenge were “clear”. The banking system needed to be returned to health, order needed to be restored to the public finances and Ireland had to regain its lost competitiveness.
Mr O’Connell said the absence of an endorsement of the National Asset Management Agency in the bulletin was an “oversight”. He said the Central Bank had been involved in approving the scheme “and it’s implicit that we think it is a good thing”.
He said the “long-term economic value” concept that was to be used to price banks’ assets was “a nebulous concept” but also a reasonable one. The European Commission would be ensuring there was no “State aid” to the Irish banks.
Mr O’Connell said there was a need to widen the tax base and to address public expenditure. He praised both the McCarthy report on potential cuts in public expenditure and the report of the Commission on Taxation. He noted that both public sector pay and social welfare payments had doubled in the 2001 to 2007 period.
Very significant savings were required to ensure Ireland moved towards meeting its Stability and Growth Pact obligations, he said. “Decisive action” would “send a clear signal to international investors with beneficial effects on the cost of Government borrowing and on the funding costs of banks”.
The bulletin said property tax had economic and fiscal merits and that proposals for a carbon tax and water charges would further ingrain the “user-pays principle”.
Mr O’Connell said the planned return to a 3 per cent deficit in the public finances by 2013 was the longest ever “slippage” granted to a country in the euro zone and he was not in favour of seeking to extend the period. To do so would mean increasing the national debt and the associated interest payments burden.
He said there was a risk involved in taking large amounts of money out of the economy but “we don’t have too many choices. We are borrowing €20 billion a year”. The bank expects Government debt to reach 59.1 of GDP by the end of this year and 73 per cent by the end of next year.
Mr O’Connell said the fees charged by professionals such as dentists, doctors and accountants had grown to “ridiculous levels” and there was scope for the Government, as a major purchaser of such services, to seek large reductions in these fees.
The bank said administered charges – such as in health insurance, utilities and transport – had continued to increase when other prices and wages were falling.
The Irish Times also reports that the future of developer Liam Carroll’s heavily insolvent Zoe group is now seriously in doubt after the Supreme Court ruled yesterday it was not entitled to continue with a second bid to secure court protection from creditors.
The decision means the group cannot go ahead with its planned Supreme Court appeal against a second High Court refusal to appoint an examiner to key Zoe companies.
The liquidation of those Zoe companies has been on hold pending the outcome of that appeal and a stay continues on that liquidation until next week when the group, in separate appeal proceedings, will urge the court to exercise its discretion not to wind up the companies.
The three-judge Supreme Court yesterday granted ACCBank’s appeal against a decision by Mr Justice John Cooke last August to allow Zoe to bring its second petition for protection, the first petition having been refused by both the High and Supreme courts in decisions last July and August.
Mr Justice Frank Clarke heard the second petition last month and refused to grant protection on grounds the group had failed to show it has a reasonable prospect of survival.
For its second petition, the group had exhibited evidence concerning its business survival plan which, against legal advice, it chose not to exhibit during the hearing of the first petition.
When refusing the first petition, both the High and Supreme courts had strongly criticised the absence of evidence to support the group’s claims of a reasonable prospect of survival.
In bringing its second petition, Michael Cush SC, for Zoe, said Mr Carroll had decided to withhold the business plan from the first hearing before Mr Justice Peter Kelly in circumstances where Mr Carroll was admitted to hospital a short time later.
There was no malevolence in Mr Carroll’s decision and the other Zoe directors had underestimated the impact of Mr Carroll’s health problems on his capacity to make such decisions, Mr Cush said.
In its appeal against the decision to allow the second petition, ACCBank, which is owed some €136 million by Zoe companies, argued the withholding of the business plan on the first occasion was an abuse of court process and the second petition should not be allowed proceed.
Allowing that appeal yesterday, the Chief Justice Mr Justice John Murray said the group had relied on material evidence in its second petition which it had “consciously and deliberately” chosen not to put before the courts in the first petition despite that evidence being available to, or obtainable by it, on the first occasion.
While there was no bad faith by the group, the bringing of the second petition in such circumstances was “an abuse of the process of the courts and the administration of justice” and it should proceed no further, he said.
The Chief Justice, sitting with Ms Justice Susan Denham and Mr Justice Nial Fennelly, said the court would give its full reasons for its decision allowing ACC’s appeal on October 14th when the group’s separate appeal against winding-up orders for some Zoe companies will also be mentioned.
The issue of costs of the protection proceedings will also be addressed then and Lyndon MacCann SC for ACC, signalled yesterday it will be seeking its costs.
The application for protection was by Vantive Holdings and Morsten Investments (the key funding companies in the Zoe group), Villeer Developments, Peytor Developments, Carragh Enterprises Ltd, Parlez International Ltd and Royceton.
Carroll case: What happens next?
The Supreme Court ruled yesterday that companies in Liam Carroll’s property development business, the Zoe Group, should not have been allowed to proceed with a second bid for protection after a first attempt was rejected.
This means the group cannot appeal the High Court’s rejection of the second application seeking court protection and the appointment of an examiner to put in place its long-term rescue plan.
The group can still appeal a decision by the High Court last month to wind up two companies at the apex of the group – Vantive Holdings and Morston Investments. However, given that both companies are heavily insolvent and that they are among the companies which failed to secure court protection under a period of examinership, it will prove tricky to argue that they should not be liquidated as agreed by the High Court.
A stay on the winding up of the two companies remains in place until at least next Wednesday when the matter will be before the Supreme Court again.
A receiver appointed by ACC to four Zoe companies last August following the failure of the first bid for protection cannot be removed following yesterday’s ruling.
The court’s decision is also expected to lead to the appointment of receivers by seven other lenders to the group over the coming days as the banks each protect their own loans to the group, which owes a total of €1.3 billion. Receivers will have first call, ahead of any liquidator, on assets securing loans if Vantive and Morston are wound up next week.
The Irish Examiner reports that Nobel Prize-winning economist Joseph Stiglitz said it would be criminal for NAMA to pay above the odds for impaired loans.
The "principle of overpaying banks for loans is criminal", he said last night when asked about the NAMA plan.
The winner of the 2001 Nobel Prize in economics warned that the global economy could suffer a "double dip", an exaggerated recovery which would then give way to another slide.
"I’m very worried about what is likely to happen in 2011 rather than in 2010," he said in a Prime Time interview on RTÉ.
The former World Bank chief economist and adviser to former US President Bill Clinton said because of the uncertainties, people in the US are not hiring, unemployment is very high and foreclosures are likely to remain high.
A sharp critic of bank bail out policies, Mr Stiglitz said these tend to aggravate crises.
"There are other ways of doing it – which is playing by the rules of capitalism.
"Which means when you can’t pay your debts, the share holders lose everything, the bond holders become the new shareholders and if that does not fill in the hole in the losses of the banks, then because the Government is going to provide deposit insurance, it becomes the owner.
"Then it [the Government] quickly sells it, or as quickly as it can, because when you have trauma like this you may not be able to do it quickly, but the joke is we call that ‘pre-privatisation’," he said.
In the US he expects unemployment to keep rising and that should be the main focus for policy makers.
A study by the ESRI has predicted that 35,000 people will be unable to pay their mortgages by next year.
The Labour Party has called for the establishment of a "home protection commission" which will identify in the short term a range of options for families faced with the threat of home repossession.
The Financial Times reports that George Osborne on Tuesday outlined plans to stop Britain “sinking in a sea of debt”.
The shadow chancellor announced a series of measures to shave £7bn off the budget deficit, which could set up an early clash between a future Tory government and public sector unions.
He urged voters to give him a mandate to make painful cuts, privately telling colleagues that he expects to become “the most unpopular man in Britain within six weeks of an election”.
Mr Osborne’s proposals would cut only £7bn a year from a deficit forecast at £97bn in 2013. But aides said they were a downpayment on a plan that would spread pain across society.
Mr Osborne repeatedly told the Tory conference in Manchester: “We are all in this together.” But his plan for a public sector pay freeze for all but the lowest paid workers in 2011 infuriated unions.
The shadow chancellor claimed that the pay freeze would help to save 100,000 frontline jobs, including nurses and teachers, but he knows that the move risks a potential “winter of discontent” in the first year of a Tory government.
Eric Pickles, party chairman, on Tuesday held private talks with union leaders to explain Tory thinking. But Dave Prentis, general secretary of the Unison public sector union, said: “It’s clear that the Tories want to use the economic recession as a stick to beat ordinary hard-working people.”
Mr Osborne insisted that everyone would help to pay down the deficit, disappointing some activists by rejecting calls for an early abolition of the 50p tax rate, to be introduced next year, and announcing the scrapping of middle-class perks such as baby bonds.
A Conservative government would also set out plans to reduce the administrative costs of Whitehall and quangos by at least one-third, or £3bn a year by the end of the next parliament, Mr Osborne said.
“These are the honest choices in the world in which we live and we have made them today. Anyone who tells you these choices can be avoided is not telling you the truth,” he told delegates.
He put bankers on notice that they faced unspecified retribution if “money that should be going into stronger bank balance sheets is unreasonably diverted into bigger pay and bonuses”.
Mr Osborne’s aides pointed to the windfall tax introduced on banks by Sir Geoffrey Howe, a former Tory chancellor, as evidence of a willingness to act on perceived excesses in the financial services sector. “I believe in the free market, not a free ride,” Mr Osborne said.
The party’s internal polling says the public is ready for honesty over the deficit, even if it means unpleasant consequences such as an increase in the state retirement age to 66 by 2016 for men and by 2020 for women.
Mr Osborne’s speech was generally well received by the City, where doubts had been expressed about his readiness for high office. Richard Lambert, head of the CBI employers’ organisation, said that it was a “serious and thoughtful” contribution.
Meanwhile, Kenneth Clarke, shadow business secretary, pledged on Tuesday to put a “star chamber” cabinet committee to cut red tape at the heart of a wide-ranging plan to reduce the regulatory burden on business.
He said: “The burden of red tape and quangos is a millstone around Britain’s neck, stifling our economic recovery and playing havoc with our public services too. We need the right kind of regulation, based on giving people the responsibility to make judgments not forcing them to tick boxes and fill in endless forms.”
The FT also reports that Nordic banks face losses on lending to Latvia under government proposals to limit the amount that lenders can collect from defaulting mortgage holders. The plans could lessen the pain of devaluation.
The Latvian government led by Valdis Dombrovskis, prime minister, confirmed on Tuesday that it was drafting legislation which would cap the amount banks could collect to the current value of properties rather than the value of the loan. This would trigger big losses for banks such as Swedbank, SEB and Nordea, which dominate the Latvian market, because property prices have fallen 70 per cent.
The move comes as Latvia’s government struggles to agree deep budget cuts needed to keep its €7.5bn ($11bn, £7bn) international rescue package on track, amid signs that some donors are losing patience with the Baltic country.
In addition to limiting loan collections, the proposals would prevent banks evicting homeowners unless lenders helped them secure an alternative residence.
Analysts said the measures would make it easier for Latvia to devalue its currency, the lat, by removing the risk that holders of foreign currency loans would be faced with sharply increased debts.
Latvia has repeatedly insisted that it has no plans to break a peg with the euro in spite of speculation that it could try to export its way to recovery by devaluing the lat.
The Latvian finance ministry did not return calls for comment on Tuesday. But Einars Repse, the finance minister, said at an International Monetary Fund meeting in Istanbul that high deficits and wages rather than the exchange rate were to blame for Latvia’s problems. He told Reuters news agency: “We will fulfil and we have to fulfil our agreement with the IMF.”
Economists said devaluation by Latvia could force neighbouring Lithuania and Estonia to follow suit and possibly trigger contagion in other troubled eastern European economies.
Danske Bank analysts said the proposed legislation would leave lenders “in a very bad position” and make it tempting for mortgage holders with negative equity to halt repayments. But they said the move could be a bargaining chip in the government’s negotiations with the IMF and European donors. “Everything might be solved overnight if a compromise can be reached, but the risk premium on Latvian banking business is sky-rocketing at the moment,” said the Danske report.
Latvia’s government is balancing pressure from the IMF for budget cuts against growing public and political resistance to the austerity measures, before elections next year. It announced at the weekend that it would cut its budget deficit by just 225m lats next year – half the amount agreed as part of its IMF-led rescue.
Fredrik Reinfeldt, Swedish prime minister, stepped up pressure on Tuesday on Riga. ”We are expected to honour our undertaking and so they have to honour theirs,” he said.
The New York Times reports that a year after Washington rescued the big names of American finance, it’s still hard to get a loan. But the problem isn’t just tight-fisted banks.
The continued disarray in debt-securitization markets, which in recent years were the source of roughly 60 percent of all credit in the United States, is making loans scarce and threatening to slow the economic recovery. Many of these markets are operating only because the government is propping them up.
But now the Federal Reserve has put these markets on notice that it plans to withdraw its support for them. Policy makers hope private investors will return to the markets, which imploded during the financial crisis.
The exit will require a delicate balancing act, government officials said.
“You do it incrementally, where and when you think you can, and not sooner,” said Lee Sachs, a counselor to the Treasury secretary, Timothy F. Geithner.
The debt-securitization markets finance corporate loans, home mortgages, student loans and more. In good times, they enabled banks to package their loans into securities and resell them to investors. That process, known as securitization, freed banks to lend even more money.
Many investors have lost trust in securitization after losing huge sums on packages of subprime mortgages that had high default rates. The government has since spent more than $1 trillion trying to restore the markets, with mixed success.
Until more of the securitization market revives, or some new form of financing takes its place, a wide range of loans needed to secure a lasting economic recovery will remain elusive, experts said.
“Given the imperative for securitization markets to fuel bank lending, we won’t have meaningful economic growth until securitization markets are re-established,” said Joseph R. Mason, a professor of banking at Louisiana State University. Mr. Sachs agrees: “It’s very important these markets come back to get credit to businesses and families who need it, and also as a sign of confidence.”
Enormous swaths of this so-called shadow banking system remain paralyzed. Depending on the type of loan, certain securitization markets have fallen 40 to 100 percent.
A once-thriving private market in securities backed by home mortgages has collapsed, from $744 billion in 2005, at the peak of the housing boom, to $8 billion during the first half of this year.
The market for securities backed by commercial real estate loans is in worse shape. No new securities of this type have been issued in two years.
“The securitization markets are dead,” said Robert J. Shiller, the Yale University economist and housing expert who predicted the subprime collapse. The government is supporting them, he said, but it’s unclear what will happen when it extricates itself. “We’re stuck,” he said.
Despite the running problems, federal officials hope to start weaning the securitization markets off government support next spring. The Federal Reserve has spent about $905 billion buying government-guaranteed mortgages in an effort to keep mortgage rates low. It will continue buying until it reaches its target of $1.25 trillion.
Complicating the Fed’s plan, banks — the other source of credit next to the securitization markets — continue to rein in lending, according to data from the Federal Reserve. And next year, banks face accounting rule changes and capital requirements that could further restrict their ability to make loans.
To be sure, certain corners of the securitization market are percolating again, thanks to the government’s Term Asset-Backed Securities Loan Facility, or TALF, which provides attractive financing for investors who buy the securities.
Bondsbacked by consumer debt — credit card debt, auto loans and some student loans — are being issued at costs close to those before the financial crisis, an indication that the market is functioning again.
But the program applies only to borrowers with stellar credit. It does not cover credit card debt or auto loans for people with blemished credit histories.
“The market is coming back, but a lot of it is because of TALF,” said Hyun Song Shin, a Princeton economist who studies securitization. “The big question is, Will the private issuance market stand on its own two feet without TALF, or has there been a fundamental change in the market that it is somehow hobbled permanently?”
That question is hard to answer as long as the government is dominating certain securitization markets. So far, the Fed has been most aggressive in supporting the market for mortgage-backed securities, which plays a crucial role in housing finance. The Fed is virtually the only buyer for these instruments, purchasing about $905 billion worth of government-guaranteed mortgage-backed securities through mid-September. Industry analysts estimate that is about 80 to 85 percent of the market.
“This is public support,” said George Miller, executive director for the American Securitization Forum, which represents the industry. “At the end of the day, the mortgage risk is held by the taxpayer.”
Investors are particularly concerned about the commercial real estate market. A big worry is that $50 billion of securitized commercial property loans are due to be refinanced in the next year. If that can’t be done, a toxic mix of declining property prices and maturing loans could lead to fresh losses at many banks.
“If there’s no mechanism, those properties will default,” said Arnold Phillips, who oversees mortgages and structured securities for the $50 billion in fixed-income investments managed by the California Public Employees’ Retirement System.
As long as the market remains closed, banks will be reluctant to make loans for commercial real estate, since they would have to hold on to them, rather than package them into securities.
Meanwhile, the programs the government has started have not changed securitization practices that many investors say were a cause of the financial crisis. Lawmakers remain concerned that when securitization comes back, it does so in a way that doesn’t put the financial system at risk.
“Our challenge is to have a robust securitization process that adds value to the economy and doesn’t undermine it,” said Senator Jack Reed, Democrat of Rhode Island and chairman of the Banking Subcommittee on Securities, Insurance and Investment. He plans to hold a hearing on securitization next month to find out why consumers and businesses are still having so much trouble getting loans.
The NYT also reports that the idea of a tax credit for companies that create new jobs, something the federal government has not tried since the 1970s, is gaining support among economists and Washington officials grappling with the highest unemployment in a generation.
The proposal has some bipartisan appeal among politicians eager both to help their unemployed constituents and to encourage small-business development. Legislators on Capitol Hill and President Obama’s economic team have been quietly researching the policy for several weeks.
“There is a lot of traction for this kind of idea,” said Representative Eric Cantor of Virginia, the Republican whip. “If the White House will take the lead on this, I’m fairly positive it would be welcomed in a bipartisan fashion.”
In addition to the economists working on the proposal, some heavyweights support the concept, including the Nobel laureate Edmund S. Phelps, Dani Rodrik of Harvard and former Labor Secretary Robert B. Reich.
One version of the approach, to be unveiled next week by the Economic Policy Institute, a labor-oriented research organization, would give employers a two-year tax credit if they increased the size of their work force or added significant hours of work (for example, making a part-time worker full time). Employers would receive a credit worth twice the first-year payroll tax for each new hire, amounting to several thousand dollars, depending on the new worker’s salary.
“It’s beautiful if it can be timed at a dire moment like this, when unemployment is way too high and appears to be going somewhat higher,” said Mr. Phelps, an economics professor at Columbia, lamenting that the president dropped it from the $787 billion stimulus plan approved in February. “But it’s a pity that this wasn’t done a year ago.”
One of a number of ideas being discussed, the policy is intended to encourage companies to start hiring again by making it cheaper to add new workers. It has raised concerns, though, that employers might try to exploit the system.
States have dabbled with similar tax credits in recent years, with mixed results. The federal government last tried this measure in 1977-78. During that period, employment — which had been soft from the 1973-75 recession — climbed at a record pace. The creation of one out of three jobs that was awarded the credit then was attributed directly to the policy. But the permanence of those jobs was less clear, and some dispute how many of those positions would have been created eventually anyway.
Supporters say that improvements upon the 1970s policy would increase its potency. These include better publicizing the credit; making it available even to concerns that are not making money, in the form of a direct payout to nonprofits and companies in the red; and distributing the credit quarterly so that companies see it sooner.
Timothy J. Bartik, a senior economist at the Upjohn Institute for Employment Research who is working on the draft with John H. Bishop of Cornell, estimates that it would cost about $20,000 for each job created.
But some dismiss the idea as corporate welfare.
“Some bad ideas never go away,” said Howard Gleckman, a senior research associate at the Urban Institute. “It’s just providing incentives to lots of companies that probably aren’t going to make it in the end anyway.”
Under the proposal from Mr. Bartik and Mr. Bishop, the credit in the first year would equal 15.3 percent of the cost of adding an employee. In the second year, it would fall to about 10.2 percent.
For example, hiring a worker might cost a small business $50,000 annually. But with the tax credit, the cost would fall to $42,350 in the first year, and then be $44,900 the next year. After that, the cost would return to $50,000.
The credit would apply only to the portion of an employee’s salary under $106,800. Lowering the cap further, however, could provide an even greater benefit to low-wage, unskilled workers.
The authors estimate their proposal could create more than two million jobs in the first year.
“Businesses like those provisions that reduce the hurdle rate that you have to surmount in order to make an investment — like an employee — a profitable investment,” said Robert Willens, president of a tax and accounting advisory firm in New York.
Of course, even in recessionary times, some companies are hiring without tax breaks. So a subsidy could merely benefit those businesses that already would have added new workers.
An American Economic Review study has suggested that the 1970s policy was responsible for adding about 700,000 of the 2.1 million jobs that were awarded the credit. This may sound modest, but if accurate, economists say it would make this proposal a successful and relatively cheap way of creating jobs.
Advocates argue that such incentives would be more effective this time around not only because of design, but also because of timing. In 1977, hiring was already on the upswing, whereas economists expect today’s job market to decline a bit more and then stagnate for months.
“Now is a better time than ’77 was because we’re closer to the bottom of a recession,” said Daniel S. Hamermesh, an economics professor at the University of Texas, Austin, who helped create the 1970s plan. “This could help an uptick proceed more rapidly.”
But critics of the idea argue that businesses hire based on actual demand for their products, and a minor subsidy for adding an employee will not make up for the collapse in demand across the broader economy.
“Why would a business hire a new worker?” Bill Rys, tax counsel to the National Federation of Independent Business, a small-business industry group, said. “They’re hiring because they need to do work. Unless you have work to do, it’s still an expense.”
Barack Obama— like Senator John Kerry before him — proposed a job creation tax credit during his presidential campaign, and then in discussions for the stimulus package. The proposal was eventually killed because of concerns that employers would exploit the tax credit. For example, companies might close and reopen, claiming credit for all their “new” employees.
Even advocates acknowledge that, as with any tax incentive, employers and their accountants will take advantage of loopholes. But they argue that with strong rules — possibly by reducing the credit for “new” companies, or by requiring a company’s overall wage bill to rise along with its work force — the proposal could minimize such abuse.
Deficit hawks still worry about the cost of the proposal, and whether it would be politically feasible for Congress to phase it out once businesses have grown used to it.
The biggest fear among some, though, is that the proposal might unintentionally reduce job opportunities if it sits in Washington too long without passing.
“Particularly for big employers, if they think a job creation tax credit is in the offing, it could certainly be an incentive to delay hiring,” said Lee E. Ohanian, an economics professor at the University of California, Los Angeles. “That means it could have the perverse effect of actually prolonging the recession.”