Understanding policy responses to weak labor demand

In a healthy labor market, eligible workers find suitable jobs, and employers find the talent they need. Unemployment is low as workers quickly match to job opportunities.

But a variety of obstacles on both the worker and employer side can interfere with how well this labor market matching occurs. Workers, who supply labor, may lack necessary skills or face other barriers to available employment, such as transportation or child care. Employers, who demand labor, may be reluctant to hire when they have limited information about workers’ qualifications or when their business conditions are poor.

Both scenarios—labor demand exceeding supply and labor supply exceeding demand—have negative consequences for the economy. Too few available workers relative to employer demand can raise recruiting costs for employers and lead to inflation by increasing wages and other labor costs. When there are too few jobs relative to available workers, families experience financial distress, workers’ skills and productivity can decline, and economic growth weakens.

Monetary policy plays an important role in addressing mismatches between labor supply and demand, but policy interventions also take place through state and federal programs. On the worker—or labor supply—side, programs designed to support workforce participation include job training and apprenticeships, family and sick leave policies, and the Earned Income Tax Credit. On the employer—or labor demand—side, programs include wage subsidies and public-hiring policies. Often these programs target workers who face economic barriers, such as those who lack in-demand skills, have weak employment histories, or come from economically disadvantaged communities. Rounding out the picture, a broader set of policies, such as those related to immigration or general economic stimulus, can also affect labor supply and demand, typically in more indirect ways.

Research on the relative costs and benefits of labor market policy interventions can help policymakers make evidence-based decisions. However, whereas labor supply policies have often been studied, some labor demand interventions have been less frequently studied and some exist only as proposals.

As part of our work to support the Federal Reserve’s mandate to promote maximum employment, the Community Development and Engagement team at the Federal Reserve Bank of Minneapolis conducted research on labor demand interventions—specifically, on public-hiring programs. Through two new studies, we shed light on how these programs affect workers’ long-term labor market outcomes, including wages. We offer these findings in the context of an overview of the landscape of major labor demand policies. Our overview starts with a discussion of wage subsidies and then turns to public hiring and our new research findings.

Encouraging hiring with wage subsidies

One way to address weak labor demand is to reduce the costs of hiring. Wage subsidies aim to boost the employment—and earnings—of workers who face labor market barriers by having the government share the cost of employing workers through tax credits or direct payments to employers. Governments at the federal and state levels have implemented wage-subsidy policies over time that vary in scope and size.

Federal wage subsidies. The largest wage-subsidy program in the United States is the Work Opportunity Tax Credit (WOTC), a federal tax credit provided to employers for hiring certain targeted groups that have faced barriers to employment. For example, some of these targeted groups include recipients of the Supplemental Nutrition Assistance Program, qualified veterans, and people experiencing long-term unemployment. Employers can apply for the WOTC to receive tax credits for, in general, 40 percent of up to $6,000 of the new hire’s wages in their first year, for a maximum of $2,400. The WOTC subsidizes wages for about two million new hires each year and has grown in scope since its inception in 1996. The WOTC replaced the Targeted Jobs Tax Credit (TJTC), which was a similar program in place from 1979 to 1994 that provided a tax credit to employers hiring specific populations.

Other recent examples of federal wage subsidies include the Hiring Incentives to Restore Employment (HIRE) Act put in place during the wake of the Great Recession in 2010 and the Employee Retention Credit (ERC) for employers affected by the COVID-19 pandemic.¹

State wage subsidies. State governments have also offered wage subsidies in targeted circumstances to incentivize the hiring of workers who face labor market barriers or boost economic activity in specific locations. One vehicle for this is place-based enterprise zones that designate an area for economic development incentives such as tax credits. An enterprise zone might provide wage-subsidy benefits to employers that create jobs in that area. For example, under Montana’s Empowerment Zone Credit, which ended in 2021, businesses that increased certain types of employment in selected areas could receive $500–$1,500 for each qualified employee in income or insurance premium tax reductions.

Most states also have wage subsidies that aren’t restricted to specific areas but are available anywhere within the state. In Minnesota, the Minnesota Job Creation Fund provides $1,000–$4,000 per job created to eligible businesses that meet job retention, creation, wage, and capital investment requirements. The fund also has elements not directly related to labor demand, such as rebates for real property improvements.

More research is needed to understand wage subsidies’ effects

Some wage subsidies have been carefully studied. These include the current federal WOTC; its predecessor, the TJTC; a variety of place-based enterprise zone policies; and many non-place-based state wage-subsidy policies. Across studies, the results are mixed. While some find modest positive effects, many find no impact on employment or wage outcomes. The research suggests that policy design might matter, including giving consideration to potential risks, such as stigma associated with program participation and subsidization of employment that would have happened regardless of the subsidies.

Overall, however, more research is needed to understand whether, when, and why wage subsidies have their intended effects. Without more research, it’s unclear to what extent wage subsidies boost labor demand and increase employment and wages among targeted populations, and to what extent they simply give money to employers that already had plans to grow and would have hired and paid workers in the same way in absence of the subsidy. When a program is targeted to a narrow group, we also need evidence to know whether—and to what degree—any additional hiring comes at the expense of groups that fall outside the program.

Directly providing jobs through public hiring

Wage subsidies aren’t the only lever available to policymakers who would like to boost labor demand. Another approach is for the government to directly provide jobs. However, there are trade-offs associated with public-hiring policies that also need to be understood.

Potential advantages of public-hiring programs include ensuring that funds go to workers, making sure the jobs meet wage and quality standards, incentivizing private jobs to meet those same standards, and carrying out projects identified as having clear public value. At the same time, public hiring carries the risk of high costs, including administrative expenses and the full cost of employment—such as wages, benefits, taxes, and overhead. Other risks include distorting the labor market by pulling workers away from the private sector and disincentivizing workers from developing skills useful for private employment.

In part due to the high costs, public-hiring policies are considerably rarer than wage subsidies. Still, there are key examples of public-hiring programs. Perhaps the most well-known examples of large-scale public hiring in the United States are programs created under the New Deal in response to the Great Depression. The largest of the New Deal public-hiring programs was the Works Progress Administration (WPA). From 1935 to 1943, the WPA employed 8.5 million previously unemployed Americans to build roads, public buildings, parks, and airports as well as to create art and contribute to cultural programs. Another New Deal program, the Civilian Conservation Corps, hired young men to improve America’s public lands, forests, and parks.² A review of studies examining the WPA and other New Deal programs shows that such policies helped alleviate hardship by increasing consumption activity, reducing crime rates, and lowering several types of mortality. However, the policies may have crowded out private sector employment in some cases.

In more recent years, the United States has not deliberately used widespread public-hiring policies as a way to boost labor demand. Most public employment has been in the form of regular government operations, with policies to boost demand limited to small pilots or workfare programs required for individuals receiving cash assistance. Even so, there are examples of large-scale public hiring that have coincided with times of high unemployment and may have helped boost labor demand, such as hiring for the decennial census in 2010 and 2020.

Minneapolis Fed studies explore wage effects and long-term outcomes

In our two recent studies of public-hiring policies, we looked at the WPA and hiring conducted in association with the 2010 Decennial Census. Our work yielded findings about public-hiring program design and long-term outcomes.

Higher wages are unlikely to affect overall unemployment but may benefit families of public employees

To provide insights on a key program design consideration, we used data from the WPA to explore the role of wages. Based on our analysis, higher wages increased WPA employment but did not help to significantly reduce broader unemployment. This may mean WPA employment had the effect of shifting employment from the private to the public sector—a possibility that was outside the scope of our findings.

At the same time, we found that higher WPA wages were associated with higher educational attainment of some teen boys living in households headed by adults employed by the WPA. This may be the result of decreased pressure on those teens to earn income for their households. Taken together, our results suggest that while higher wages are unlikely to affect overall unemployment, they may otherwise benefit the families of workers employed by public-hiring programs.

Public hiring may improve long-term labor market outcomes for marginal applicants

To better understand a more recent type of public hiring, we looked at data from 2010 Decennial Census employment. In this case, the federal government hired more than 850,000 individuals to help with data collection and related activities during a time of high unemployment in the United States. We found that temporary census employment had no long-term impacts for workers on average, but that it dramatically changed outcomes for marginal applicants who barely passed their census hiring test.

Compared to similar applicants who were not hired, marginal applicants hired for a census job were, unsurprisingly, much more likely to have a job in 2010, the year of the decennial census. Less obviously, their increased likelihood of receiving a W-2, the federal tax form that documents wage employment, persisted over our analysis period through 2023. In 2023, marginal applicants who were hired for the 2010 Decennial Census were 28 percentage points more likely to receive a W-2 than similar applicants who barely failed the screening test and were not hired. One possible reason why even marginal census employees saw higher long-term earnings is that their having passed a background check and carried out a job requiring high levels of trust may have been a positive signal to future potential employers.

While these applicants were more likely to work after 2010, their wages were comparable to wages of those who barely failed the screening test and were not hired by the census but were employed elsewhere. Even without long-term wage impacts, the higher long-term employment of the marginal census workers had implications for the tax revenues collected from them, which may be a consideration in assessing program costs and benefits. As shown in the figure below, even though their post-2010 wages were similar to the wages of those who barely failed the screening test and weren’t hired by the census, the marginal census employees’ higher likelihood of working translated into nearly $6,000 more in W-2 wages per year after 2010, on average. Over time, this increase in wages would yield additional tax revenue for the government.

Extending government employment to all qualified workers through job guarantees

The most ambitious type of public-hiring program comes in the form of proposals for so-called job guarantees. In one variation, job guarantee policies offer government jobs carrying out publicly beneficial projects to all qualifying workers who seek employment, and not just for a limited purpose such as carrying out a decennial census.

Although job guarantee policies remain at the proposal stage in the United States, versions of job guarantees have been implemented elsewhere. Among the largest job guarantee programs is India’s National Rural Employment Guarantee Act (NREGA), which provides at least 100 days of guaranteed paid employment per year for rural households whose adult members provide unskilled manual labor. Studies of India’s NREGA have found the program to have boosted consumption, employment, and wages, while crowding out some private employment and potentially reducing school enrollment.

Research informs labor demand policies

Research on approaches to strengthening labor demand—and on the circumstances in which those approaches are more and less effective—supports policymakers in determining how best to foster maximum employment, especially during economic downturns. Our team’s recent studies add to the literature on direct hiring as one form of intervention.

More research is needed to provide robust evidence of the relative costs and benefits of the various employer-side approaches to strengthening labor demand. Future studies could explore which populations benefit from which types of policies, how these policies affect other societal outcomes, and what policy parameters influence the efficacy of these policies.

Endnotes

1 The HIRE Act included a payroll tax exemption that was equivalent to the employer’s share of Social Security taxes for wages paid to eligible new hires. An additional tax credit of up to $1,000 was available for those retained for at least one year. The ERC provided a maximum credit based on qualified wages of $5,000 per employee in 2020 and $7,000 per employee per quarter in 2021 for eligible employers.

2 Beyond the New Deal, the Comprehensive Employment and Training Act (CETA) of 1973 is another example of large-scale public hiring. Under CETA, the federal government subsidized state and local governments for vocational training and public service jobs for unemployed and disadvantaged workers. Restrictions on how governments could allocate the public service funds were added over time until the program ended in 1982.