With more than 14 million unemployed American workers and an unemployment rate stubbornly above 9 percent, perhaps the most vexing economic issue of our day is how to create new jobs.
If we can put these Americans back to work, they will once again be paying taxes instead of collecting unemployment benefits, which will largely take care of our budget-deficit problem. But how can we create new jobs without spending additional hundreds of billions of dollars, on top of the $787 billion spent on the Obama administration’s 2009 stimulus plan, which has failed so spectacularly? What if I told you that there is a “free lunch” with respect to job creation, if only we were to change some simple, yet onerous, employment regulations on small businesses?
I am a small-business owner, but I am also a pointy-headed academic - a professor of finance - who has studied small businesses for almost two decades, so I have a unique perspective on how to create new jobs. My small business needs to hire its first employee. Why is this important? Because new research indicates that almost all new jobs are created by young and small businesses hiring their first employees. That said, I will not be hiring my first employee. Why? Because it is just too expensive. Let’s look at the costs and benefits.
If I am to pay my new employee $20 per hour, or $40,000 per year, how much will it actually cost me to hire this worker? Let’s assume my pay is $125 per hour, or $250,000 per year, which puts me into the bottom of President Obama’s “millionaires and billionaires” earnings bracket that includes so many entrepreneurs. Each quarter, I will have to file IRS Form 941 - Employer’s Quarterly Federal Tax Return. The government estimates it will take me 15.7 hours in recordkeeping and preparing the form each quarter, for a total of 63 hours per year. Each year, I also will have to file IRS Form 940 - Employer’s Annual Federal Unemployment Tax Return. The government estimates that it will take me 12 hours in recordkeeping and preparing the form each year. At my assumed $125 hourly rate of pay, just these five forms will cost me 75 hours at $125 per hour for a total cost of $9,375 per year.
I also will have to pay half of my employee’s Social Security and Medicare taxes, or another $3,000 plus unemployment tax equal to 6 percent of the first $7,000 in wages, or $420. So, to pay my employee $40,000, it will cost me $43,420 out of pocket, plus an opportunity cost of $9,375, for a total of $52,795, or 32 percent more than the $40,000 I had hoped to pay my first employee. Moreover, there are serious monetary penalties should I miscalculate the withholding taxes, not to mention the additional time required to file amended forms. And there are undoubtedly other regulatory-compliance costs that I have overlooked. Now I decide that I will not hire a new employee.
What if we change the rules of the game for the smallest of small businesses? What if we allow small businesses to hire their first one (or two or three) employees as independent contractors, doing away with all of these regulatory burdens? The huge fixed costs of hiring a first employee disappear immediately. According to the U.S. Census Bureau, there are more than 20 million zero-employee firms in the United States with almost a trillion dollars in annual sales. If only a fraction of these firms decide to hire their first employee, this could be a game-changer, boosting employment by millions.
What is the downside? Zero. This can be a revenue-neutral deal. My employee would still pay Social Security and Medicare taxes but as an independent contractor, he would be responsible for the full 15 percent rather than only the half that salaried employees pay. I would be willing to pay the employee an additional 7.5 percent to cover these taxes; I would be paying that amount anyway under current rules. The big savings come from the elimination of the reporting burden that frees me up to do productive work for my clients, rather than do unproductive paperwork for Uncle Sam.
Rebel A. Cole is professor of finance and real estate at DePaul University.