Payroll tax cuts now!

by on October 7, 2009 at 9:45 am in Economics, Law | Permalink

Support appears to be growing (finally!) for a payroll tax cut.  Here’s Edmund Phelps

“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.”

I argued in favor of a payroll tax cut (and other supply side stimulus ideas) earlier this year so I am in agreement that this is late but still warranted.  Other economists in favor of a payroll tax cut include Keynes, Tyler (in his usual manner), Arnold Kling, Greg Mankiw, Russ Roberts, Robert Reich and Dani Rodrik.  The list could easily be extended and it easily crosses political boundaries.  Lee Ohanian is quoted in a negative manner arguing:

“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.”

But if you think that the potential for a future tax cut can delay employment today that is another way of saying that an actual tax cut would greatly increase employment today so I count Ohanian in favor if it can be done now.

John Thacker October 7, 2009 at 9:54 am

Yes, it could easily be bipartisan. The McCain/Republican alternative stimulus earlier in the year had as its centerpiece a fairly large payroll tax cut instead of new spending (besides the common extension of unemployment benefits).

sam October 7, 2009 at 10:03 am

excuse me for possible ignorance, but would the proposal reduce the amount of FICA, etc. paid by my employer or reduce the amount of FICA, income tax paid by me?

Luis Enrique October 7, 2009 at 10:21 am

How large are demand multipliers? (I mean, if all firms decide to hire more workers, how much does the resulting decrease in unemployment boost demand for what the firms produce?). If demand is taken as given, then a reduction in payroll taxes will make a difference to hiring at the margin, but it would be surprising for it to achieve much, as Steve C suggests above. But how are firms forecasting demand? (how are expectations formed?) If firms expect all other firms to increase hiring, will they anticipate an increase in demand? Could this sort of thing be a “sunspot” that moves us to a higher equilibrium?

Colin October 7, 2009 at 10:58 am

I don’t see how a two year tax credit is useful. It does nothing to change long-term incentives or planning. When you are considering hiring a worker at an annual salary of even $30K — which will cost you even more when health insurance and payroll taxes are added — saving a few thousand is unlikely to change your calculus.

Long-term planning is another reason why companies are loathe to hire workers now. With cap and trade, health care and likely tax hikes on the horizon, who wants to be hiring in this environment.

If Obama really wanted to promote job growth he could focus on reforming the tax code (loophole and credit reductions in exchange for a rate cut on the corporate tax rate for example) and eliminating the linkage between employment and health care. Heck, even passing bilateral agreements with Panama, SK and Colombia would send the right signal.

Andrew October 7, 2009 at 11:37 am

The hiring/firing incentives aren’t symmetrical either.

I’ll take Steve C. one further. I think people hire because they are terrified their competitors are getting ahead. So they hire sub-par workers and keep on those they despise. When the recession comes they are first glad to be able to get rid of those they didn’t like all along. In boom times, nothing short of axe murder will get you fired. Then, the recession comes and the company ramps up their drug testing and makes sure you are aware of the cardinal work rules and starts enforcing all kinds of stuff. But new hiring would help the recalculation while keeping existing workers would not. So, why not dump it to the states, give them a few choices, maybe a placebo and see what happens?

Mike October 7, 2009 at 11:41 am

Labor demand tends to be pretty inelastic, so I don’t think a new job payroll tax reduction would really influence employment a great deal. Furthermore, it is price distortionary, which creates perverse incentives. Why wouldn’t a business make a round of layoffs and then hire some new people in order to qualify for the tax credit? Maybe protections could be put in place, but I’m not sure all of the unintended consequences can be anticipated. I prefer demand-side stimulus, and think it is more effective, though clearly it takes time. In the interim, I favor increased/extended unemployment benefits and aid to state and local governments.

Joshua October 7, 2009 at 12:03 pm

A payroll tax cut on all jobs would be better… harder to game, and it would reduce current employers’ incentives to lay people off.

Seward October 7, 2009 at 12:04 pm

Speaking of taxes, unions don’t want their health insurance taxed to pay for ObamaCare: http://www.politico.com/news/stories/1009/28013.html

SR October 7, 2009 at 12:12 pm

The UK Conservative party has announced a temporary freeze for payroll taxes (National Insurance Contributions) for new businesses if they win. http://news.bbc.co.uk/1/hi/uk_politics/8291439.stm

DWAnderson October 7, 2009 at 12:22 pm

As several other commenters have alluded, the NYT article you link to does NOT discuss growing support for a payroll tax cut, RATHER it discusses support for two-year tax credit for new hires. THAT is a bad idea leaning toward wasteful attempts to game the system as Mankiw identifies in his post today. All of the mechanisms identified in the article to deal with attempts to game the system are fraught with their own negative unintended consequences. A payroll tax cut seems like a good idea; a credit for “new” jobs does not.

mulp October 7, 2009 at 1:05 pm

Name three times when broad based tax cuts actually resulted in increased employment within a year after passed.

Name three times when tax hikes during a period of falling employment failed to be followed by increased employment within six months.

While the logic seems sound, I can’t find any examples where reality reflects the argument in favor of tax cuts during a period of falling employment.

And I would point out that the tax cut to stimulate the economy from 2001 are still in effect, as are some of the 2002 tax cuts to create jobs, some of the 2003 tax cuts to create jobs, the 2004 tax cut bill that sped up the 2001 economy stimulating 2001 tax cuts, the 2006 tax cut bill to speed up or extend the provisions of earlier tax cuts, and the 2008 tax cuts to stimulate the economy, not to mention the 2009 tax cuts.

Tax revenue to the Federal government is now at the lowest share of GDP since WWII as far as I can tell.

I would point out that the predictions were that the Clinton tax hikes piled on top of the Bush tax hikes would push the US economy into a long and painful recession with high unemployment.

I do know the impact of one type of tax legislation that is probably rather distortive and inefficient, but it does stimulate a lot of business activity: tax rules that allow writing off capital investments immediately or rapidly for all equipment bought, all factories built or retooled for manufacturing, and all R&D research done. Corporations will scramble to turn everything into immediate expense write-offs which might only be a huge higher boom for tax accountants and bean counter and government form paper pushers. These deals really get crazy when the tax benefits can be transferred from a not for profit or money losing enterprise to high profit corporations and individuals, as for example, the depreciation of subway cars owned by a city transit authority. Such accelerated depreciation and writeoffs for a period of three years would pull in half the investment for the next decade into the second and third year, while increasing the investment in the next decade by fifty percent.

Seward October 7, 2009 at 1:31 pm

mulp,

The Clinton tax hikes had built in delays and they were riven with all manner of outs during and after that delay period. The devil is in the details as they say.*

*Also further illustrating that the U.S. tax code’s language is susceptible to a lot of bidding.

Rich Berger October 7, 2009 at 2:04 pm

Mulp-

George HW Bush raised taxes in 1990 – unemployment went up. George W Bush cut taxes in 2003 – unemployment went down.

mulp October 7, 2009 at 2:12 pm

Seward, sorry, but the tax hikes were retroactive in a number of aspects, and the delays of provisions were in terms of allowing the law to be implemented and to adjust to the new tax law. The previous Bush tax hikes were also retroactive in some aspects with other provisions delayed, but were entirely in effect by the time the Clinton tax hikes were added on to the Bush tax hikes.

The tax cuts of the 70s were bracket adjustments to account for inflation, so they were in a number of cases reductions rate that taxes were increasing from higher wages in response to inflation. The Reagan 1981 tax cuts went beyond the effect of inflation by reducing that rates as well as increasing and eliminating the brackets, indexing didn’t begin in that act until 1984, so the effective taxes collected by the 1981 tax cut bill increased as inflation continued to drive up wages and incomes subject to taxes. Further, a number of provisions of the 1981 bill weren’t to go into effect until the end of 1982, that those provisions were repealed in October 1982. Still that bill did drastically cut the taxes collected even as employment fell for the following 16 months.

DanC October 7, 2009 at 2:14 pm

mulp

Clinton benefited from a big drop in oil prices which offset some of his tax increases.

The W Bush tax cuts are gone as far as forward planning goes. Everybody know that Obama has buried them.

The direct impact of the payroll cut is not that it is enough to stimulate hiring, but it may stimulate consumption. Just think of it as a helicopter drop of money into the economy. Compared to other stimulus spending it has the advantages of being quick, progressive (helps lower income more), uncomplicated, less political, and does not create incentives for people to game the system.

coberly October 7, 2009 at 2:54 pm

There are three kinds of people in favor of this idea:

those who hate social security and want to destroy it.

those bleeding hearts who want any break for the “poor” that they can find.

the non partisan stupid.

as “most economists” will tell you the payroll tax is “the employees money” so it clearly is not a tax on employment. moreover it is the employees money that they save… via the payroll tax… so they will have enough to retire on. you would understand this better if you knew that Social Security was not welfare.

but judging from the comments so far, stupidity has won the day.

coberly October 7, 2009 at 3:07 pm

sorry for the double post.

Seward October 7, 2009 at 3:56 pm

Steve C.,

Well, it is used not just for that. It is also used for general government expenditures. So Coberly would have a point if those funds were actually used for retirement.

coberly October 7, 2009 at 4:28 pm

i am figuring out this posting thing.

the retirement savings of the workers has been collected in advance of the needs of the baby boomers to correct for an otherwise generational inequity. like sensible people the Trust Fund is “invested” not kept in a “lock box.” The invested money is used for other government expenses, but it still has to be paid back… unless of course the flim flam artists can convince you to do something stupid, like give the money back to the workers so they can take it to wall mart and buy something they really need. and of course the bosses can take their share of “the really the employees money” and use it to hire another minimum wage worker, or just buy that new Lexus.

is there anybody out there who has actually sat down and thought this through?

mulp October 7, 2009 at 4:40 pm

George HW Bush raised taxes in 1990 – unemployment went up. George W Bush cut taxes in 2003 – unemployment went down.

Employment had been falling for five months prior to Bush signing the 1990 tax hikes which didn’t go into effect until 1991, and were phased in over several years. Employment stopped falling six to seven months after Bush signed the tax hike bill.

While employment had been falling since January 2001, it continued falling after the Economic Growth and Tax Relief Reconciliation Act of 2001 was signed in June 2001, some provisions were retroactive while others were phased in reductions over the following nine years. Employment continued falling as the Job Creation and Worker Assistance Act of 2002 was signed in March 2002, which provided retroactive business tax cuts by allowing losses to be carried back to past tax years. Employment losses paused in the months afterward, and then resumed falling until after Jobs and Growth Tax Relief Reconciliation Act of 2003 was signed in May of 2003. However, nearly every tax cut provision was already scheduled to tax effect from the 2001 tax cut, so the only effect was to speed up the implementation of the 2001 tax cuts. Only in June 2002 did the fall in employment flatten, but then it resumed falling and ony after hitting the low in June 2003 did employment begin rising. Accelerations of cuts in the 2001 bill, extensions of cuts in the 2001 bill, plus added cuts were signed into law in Oct 2004 (Working Families Tax Relief Act of 2004 and American Jobs Creation Act of 2004), in May 2006 (Tax Increase Prevention and Reconciliation Act of 2005), and February 2008 (Economic Stimulus Act of 2008).

It took from June 2001 when the 2001 tax cut was signed until October 2004 for employment to return to the level when the bill was signed. And as no tax hikes have been implemented and no tax cuts allowed to expire, and yet more tax cuts now in effect with American Recovery and Reinvestment Act of 2009,
employment has fallen well below the level of June 2001 as of June 2009.

Note, I am using employment numbers without taking into account the increasing population of working age.

Care to explain how the many tax cuts since 2001 have helped increase employment and stimulated the economy? Perhaps the shadow banking system monetary bubble expansion had more impact on the increase in employment than tax cuts?

Of course, many of the tax cuts promoted more bubble creation by favoring converting labor income into asset bubble gains, while punishing labor income by taxing it at higher rates than creating asset bubble income.

mulp October 7, 2009 at 5:07 pm

You might also note that during the “worst economy in 50 years” during 1992, Real GDP went up by more (3.4%) than it did in the year of the Clinton tax increases 1993 (2.9%). The Clinton tax increases were supposed to reduce the deficit, but the deficits were still in the 200BN range when the big budget showdown of 1995 took place.

See, the Bush tax hikes of 1990 were having a very positive impact, and as we know, employment is a lagging indicator.

Thanks for pointing out the additional stimulative effect of the 1990 tax hike.

For the 21st century, we do have the tax policies that promoted all efforts to promote asset price increases with regulatory changes that made it highly lucrative for the shadow banking system to engage in massive monetary expansionary policies driving both employment building unneeded real estate and also creating a stock market bubble so that increased imports could keep price levels constant and limiting inflation. But the asset bubble popped and the shadow banking money supply contracted sharply, and is still contracting.

The tax cut created deficits plus the employment contraction has increased the Federal deficit greatly so the monetary contraction is being offset by Fed funding massive Keynsian deficit spending to boost GDP.

Those who have income and are benefiting from the tax cuts are not investing their incomes productively in the economy, nor even spending it on consumption, basically all they are doing is giving it to the government in the form of treasuries so the government can spend it or give it to people who will spend it on consumption. It would make more sense to tax those who have the excess cash and aren’t investing it productively.

To get them to invest productively, I would be in favor of them being able to buy tax credits on accelerated depreciation on wind and solar power farm, on manufacturing plants making solar cells or battery plants, or best of all, immediate writeoff of R&D toward sustainability, or just about anything. From a business investment accounting standpoint, capitalizing R&D is the only rational way to run the finances of a business, but from a policy standpoint I want all the incentives possible to do more R&D immediately. A 50% tax rate on Warren Buffett or Bill Gates won’t hurt them if they have the option of avoiding the taxes with tax dodges that let them use tax money to fund 50% of the R&D they identify as marginally profitable without the high taxes and tax credit dodges. Such tax laws are unfair because only the rich with the complex finances that already result in armies of tax accountants needed to exploit them, but a temporary five years of complexity in this form is easier to ramp up than an equivalent amount of government investment in R&D.

For the long term, more rational incentives for real productive investment are needed instead of the fake investment that is really consumption of the past decade, but for the moment, a decade of bad policy that has killed real investment needs to be compensated for.

libert October 7, 2009 at 5:30 pm

@ Rich

Reagan cut taxes in 1981 – unemployment went up. Reagan raised taxes in 1982 – unemployment went down.
Clinton raised taxes in 1993 – unemployment went down. Obama cut taxes in 2009 – unemployment went up.

We could play this all day, but neither your statement nor mine proves anything. Beware omitted variables!

Rdan October 7, 2009 at 5:46 pm

Tyler,

I think using the payroll tax is mis-guided and has intended or unintended consequences that would be regrettable. If a tax cut is done, call it something else and leave social security alone. It is working fine to date, and such a move is not necessary through Soc. Sec., even if one thinks the tax cut would have the intended impact.

mulp October 7, 2009 at 6:41 pm

The W Bush tax cuts are gone as far as forward planning goes. Everybody know that Obama has buried them.

The 2001 tax cuts promised lots and lots of tax cuts in the future, so all those future tax cuts should have been pulled into the present, especially because unless employment shot up and resulted in economic boom trickle down, the tax cutters would be booted from office and taxes would be hiked.

But I suppose we can reason that the 2001 through 2009 tax cuts have been discounted because they were seen to lead to the conservatives being booted out and liberals elected to raise taxes and increase regulation, so it was open season on plundering the economy any way possible, like slashing employment to boost apparent earning to more highly leverage capital to generate dividend and capital gains that were taxed at drastically reduced rates.

In other words, the Bush tax cuts were a signal to go after short term capital gains and expect long term economic doom.

DanC October 7, 2009 at 7:59 pm

Mulp

Let’s go back.

March 2000 tech bubble burst
September 11, 2001 terror attack
Late 2001 Enron collapse leads to jump in corporate bond rates as accounting scandals grow.

Three huge negative demand shocks hit the economy. The fact that the following recession was so shallow and ended rather quickly is the result of what?

The tax cuts were temporary and to some degree it encouraged short term thinking. When Obama took a clear lead in the polls, and it became clear that additional taxes and regulations were coming, what happened to the economy?

BTW most economic historians will say that Clinton had two favorable supply shocks. The growth of HMO’s slowed the growth of health care costs for a time. Productivity had a big boost thanks to the computer revolution (remember when companies had account receivables departments). Of course all this “New Economy” talk had trouble when the tech bubble burst. Combine with lower oil costs. Plus his support of things like NAFTA and welfare reform. Made the tax increases less of an issue. Plus when times are good the automatic stabilizers in the economy spend less and the budget looks better, regardless of additional taxes.

Yancey Ward October 7, 2009 at 9:51 pm

The very fact that so many economists support it cuts against it being a good idea, in my opinion.

Could we start making some solid, long-term plans to address cutting the costs of hiring? Too much to hope for, I suppose.

Bruce Webb October 7, 2009 at 10:28 pm

Payroll tax holidays as a hiring stimulus or as offsets for consumption taxes are just too smart by half ways of defunding Social Security and Medicare and transforming a mostly phony Entitlements Crisis into a real one.

Hasset and Biggs of AEI and the people around PGP spent March and September whipping up hysteria around what they call ‘Vanishing Surpluses’ in Social Security and the policy response is to slash revenues even farther?

I understand why payroll tax cuts ‘temporary’ or permanent are popular with Libertarians who don’t believe in Social Democracy to start with. But it drives me crazy to see Robert Reich and also some of the young left leaning policy wonks embracing this by thinking they are somehow making the tax system more progressive.

Instead they are just stepping into a trap set by Cato and the Economics Department of GMU who fondly imagine that New Dealers won’t see through this transparent attempt to piss on FDRs grave by bleeding dry the heart of the New Deal.

We are not fooled. Nor are we amused. Not unless and until someone openly quantifies the impact of this proposal on Medicare Part A and Social Security.

babar October 7, 2009 at 10:34 pm

i have an idea! why just social security? let’s declare a ‘savings holiday’ and stop people from putting their moneys away into 401ks and pension funds. more or less that’s the same thing, right? and that would solve the problem with the savings rate going too high. spend it or it will get taxed. aggregate demand pops through the rooooooooof!!!

mulp October 7, 2009 at 11:54 pm

The link in the previous blog entry to the column on Bartlett includes this, among other statements relevant to this tax cut cheer:

For one thing, past tax increases have not choked off economic growth. The 1980s boom didn’t immediately follow the 1981 Reagan tax cut; it followed his 1982 tax increase to reduce the deficit. The 1990s boom followed the 1993 Clinton tax increase. Tax rates matter, but they’re nowhere near the main force affecting growth.

and this comment on conservative economic policy:

Mr. Bartlett writes. “What remains is a caricature — that there is no problem that more and bigger tax cuts won’t solve.†

coberly October 8, 2009 at 8:57 am

Dan C and Seward

you are right that this is a waste of time. you appear to have learned everything you know from reading Peterson and Cato… or their derivatives. I don’t think anyone can teach you anything, but if you ever have a glimmer of intellectual honesty you’ll try to find out what you don’t know. Or think about what you do know that ain’t so.

If you buy a stock today, and sell it forty years from now, is that an “inter generational transfer of funds”?

mulp October 8, 2009 at 8:40 pm

Reagan cut taxes while the Fed was pushing interest rates to all time highs. The Reagan path was to grow the private economy through innovation and real growth. Reagan was interested in real sustainable growth. Reagan was decisive in international relations and had clear objectives on the economy. He turned the country to a better tomorrow after Carter.

Reagan cut taxes once and raised taxes five or six times, and the employment growth occurred after the tax hikes. And tax 1981 tax cut had a built in tax increase because the brackets weren’t indexed until 1984 which lower the brackets by 10-20% raising taxes.

Reagan raised the Social Security tax rates significantly while reducing the benefits and then in the great tradition of Keynesian economics, engaged in massive deficit spending, spending every dime of the increased flat tax on the poor, middle class, and lower end rich that is known as Social Security.

Half the 1981 tax cut wasn’t to go into effect until 1982, and that was eliminated in the 1982 tax hikes Reagan signed. Other tax reforms ended up increasing taxes.

So, in the end, Reagan got the benefit of lower energy prices as the CAFE standards kicked in, the shift from petroleum to coal for producing electricity, higher energy efficiency for all areas on the economy, as well as all the new oil fields beginning to produce, all actions initiated and taken before Reagan took office. Yet with the lower inflation, the lower petroleum prices, job growth was below the rate for the Carter term, even for Reagan second term.

And let’s consider employment for Reagan’s first six months:
January employment: 91,031,000
July employment: 91,594,000

So, the economy Reagan inherited from Jimmy Carter was one adding jobs.

Reagan’s sustainable growth was surpassed by Clinton’s sustainable growth which was based on the bipartisan higher taxes of Bush-Clinton which led to a projected paying down of the external government debt instead of the unsustainable debt increases of Reagan’s economic policies.

We also had a credit crisis in the early years of the Reagan years that festered and resulted in lots of S&L and bank failures and the government bailouts of the financial system which has been replicated over the past two years. You should ask why it is that we were able to go a half century without a major banking system failure, and then with the deregulation of banking and finance we have had problems so big the government has had to step in like Hoover and FDR did into the banking and credit system. We have seen a return of the financial crisis every 10-15 years that were the pattern from 1800 to 1935 since Reagan’s “get the government out of the way” changes.

And let’s remember the high inflation, wage and price control unwinding, the oil embargo, the sharp increase in oil prices, Carter appointing Volcker who started tightening the screws on credit. But unlike Reagan, Carter didn’t make the credit squeeze worse by running a much bigger deficit so government was consuming the limited credit the Fed was offering and thus drying up credit to business.

As for innovation, having grown up in the 50s and 60s, and started working in the computer industry at the end of the 60s, I can assure you that the innovation was already baked into the US economy. And if anything, the amount of innovation decreased in the 80s; after all, it requires innovation to be competitive in the manufacturing industries, and since the 80s we have had lots of apologists saying that highly skilled manufacturing jobs aren’t the kind of work for Americans who are better served in low skilled service jobs.

So, I really can’t see where I’m rewriting history, though I am seriously challenging the Reagan mythology, though my real challenge is to the lower taxes result in a better economy mythology.

Fran October 12, 2009 at 8:49 pm

Got a friend in vawncast he is going to love this.

Jibran Ayub October 2, 2010 at 2:50 am

Labor demand tends to be pretty inelastic, so I don’t think a new job payroll tax reduction would really influence employment a great deal. Furthermore, it is price distortionary, which creates perverse incentives. Why wouldn’t a business make a round of layoffs and then hire some new people in order to qualify for the tax credit? Maybe protections could be put in place, but I’m not sure all of the unintended consequences can be anticipated. I prefer demand-side stimulus, and think it is more effective, though clearly it takes time. In the interim, I favor increased/extended unemployment benefits and aid to state and local governments. BrownsbergerBrownsbergerLudermanTrujilloGaravagliaSowinski

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