Friday, September 3, 2010

Payroll Tax Holiday with a Twist

There is a lot of chatter right now about whether a payroll tax holiday would provide an effective stimulus to the slumbering U.S. economy.  The motivation for this chatter is the news that the White House is considering, among other things, some kind of payroll tax cut.  The discussion so far has been mixed with some folks like Scott Sumner, Tyler Cowen, and Arnold Kling endorsing it while others like Megan Mcardle and Mark Thoma expressing uncertainty as to how much stimulus it would actually provide.  Mark Thoma concludes his discussion of this proposed tax cut with the following:
Thus, the overall effect on employment depends upon the net effect of the AD and AS shifts. If the AD shift dominates, as I suspect it would, it's still possible for this policy to have positive effects on output and employment. But the size of the effect depends upon the strength of the demand side shift, and how strong the shift would be is an open question, particularly given the degree of household balance sheet rebuilding we are seeing which causes the tax cuts to be saved rather than spent.
See the rest of Thoma's post as to why a payroll tax could affect both aggregate supply (AS) and aggregate  demand (AD).  One way to make sure the AD effect dominates would be to do the payroll tax holiday in the manner I suggested a few days ago: have the Federal Reserve (Fed) fund the payroll tax holiday with a "monetary gift" to the Treasury department and at the same time commit the Fed to doing so until a certain nominal target (e.g. a price level target) is hit. As discussed in the comments in my previous post, only part of this funding would truly be a "monetary gift" from the Fed. Still, the announcement of a nominal target to complement the payroll tax holiday would go a long ways in stabilizing the nominal expectations.

With all that said,  I am not advocating this approach as my first-best solution. I would rather go with  more aggressive monetary policy along the lines Scott Sumner discusses here.  If, however, there is going to be a payroll tax holiday, why not make it more effective by bringing in the Fed's money helicopter?  The biggest impediment to this proposal is a legal one, it would require Congressional approval.

Update:
  I overstated Tyler Cowen support for the payroll tax cut.

9 comments:

  1. Excellent commentary.

    I agree with many structural changes that would help the economy. We could cut payroll taxes, we could shrink the military, reduce the rural welfare archipelago, cut the minimum wage etc etc etc. But discussing such issues gets us into politics off-track of the Main Line--Fed policy.

    Growth Hawks now must frame the argument re the Fed. It is Growth Hawks vs. The Japan Wing of the Fed.

    Scott Sumner has proposed a solid, workable plan. We should all back it.

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  2. David, Are you sure Tyler endorsed it? BTW, I endorsed the concept, if it is across the board, and if it only applies to the employer share. Recently I came across articles suggesting neither of those assumptions will hold. In that case I probably won't endorse the actual proposal.

    And thanks for plugging my monetary stimulus idea.

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  3. Scott,

    I totally agree - the Payroll tax holiday needs to apply to the employer side too.

    Plus, it probably needs to be at least 8% total.

    My preferred construction of this would be:

    1. Complete holiday for 4 months. Holiday includes employer portion of the tax.

    2. Taxes would phase in 25% at a time from the time of the announced phase out, so plan would take at least a year to phase out completely.

    3. Phase in plan could be delayed at any point for an additional 3 months, depending on economic conditions. So if the economy wasn't recovering, the next level of phase it could be delayed for another 3 months.

    This might be too much stimulus. I would rather error on the high side at this point. I am open to starting at a 50% holiday and then have a similar phase out plan.

    The idea of a tax holiday is really only useful for business planning if the exit plan is clear and known in advance. Business expectations are a huge factor in our economy. A recent JP Morgan study said about 87% of the current downturn is due to expectations of business being low vs. 12% for political and regulatory concerns.

    If the expectations for businesses aren't clearly going to be good for an entire year or more, then there is no point in hiring. So, it needs to be really, really clear that this stimulus is both huge and will last a long time - long enough to justify hiring.

    Corporate profits are up for the S&P 500, but I bet if you ask small business owners, they would say they are down. We need to put more money in the pockets of the lower 80% of people and businesses for there to be a sustained recovery.




    Payroll taxes are about

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  4. This week Senate Minority Leader Mitch McConnell suggested suspending the Social Security payroll tax for a period of time, as a stimulus measure. A payroll tax holiday, however, would both be costly — a two-month suspension could cost about $120 billion, for example[1] — and likely relatively ineffective as a stimulus measure. Public resources would be better spent on stimulus measures with a higher “bang for the buck,” such as the Making Work Pay tax cut that President-elect Obama has proposed.


    I say, give the EMPLOYEES a two month payroll tax holiday on their share of the tax, but do it according to Obama's "Making Work Pay" method, to pump the money back into the economy, not wealthy savings that aren't even creating small business loans.

    http://www.cbpp.org/cms/index.cfm?fa=view&id=2264 for the reasons why this would be more effective.

    Then give the EMPLOYERS a tax holiday every other month for the next year, based upon the ratio of new hires to the existing payroll headcount. For example, if the company increases the payroll headcount by 1%, they earn the payroll holiday for every new hire; by .5%, they earn a holiday for every other new hire at an equal or lesser pay rate.

    For companies who increase payroll by 4, 5 or 6%, they should get the payroll holiday for a matching number of positions at the same or lower pay rate than the new hire. That is, for a payroll increase of 5%, the employer gets the payroll holiday for each new hire plus 4 existing employees at the same or lower pay scale.

    As they continue to hire, their tax savings in the remaining months increase, but they are not retroactive and the program ends in a year, encouraging corporations sitting on huge piles of cash to hire soon and often.

    By basing it on an increased head count, those hired as replacements do not unjustifiably trigger the tax holiday. Also, this method of scaling the benefit is fair to all sizes of employers.

    By all means, let the Bush tax cuts expire for those earning $250K or more. 70% of Americans support this. Only 3% of those incomes belong to small business owners. So the argument that it will stifle job creation is DOA. Any taxes saved by the wealthy do little to stimulate commerce, compared to the average wage earner. They just go into savings, and the banks aren't even using them for small business loans. The average wage earner spends the majority of every additional dollar earned.

    Eliminate tax cuts and loopholes for oil companies, unless they are investing in new forms of renewable energy. We don't need to grow our dependence upon oil; we need to replace it. Use the taxes recouped from both of these to fund the tax holidays and programs to enable local banks to loosen up the tight credit for small businesses.

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  5. This week Senate Minority Leader Mitch McConnell suggested suspending the Social Security payroll tax for a period of time, as a stimulus measure. A payroll tax holiday, however, would both be costly — a two-month suspension could cost about $120 billion, for example[1] — and likely relatively ineffective as a stimulus measure. Public resources would be better spent on stimulus measures with a higher “bang for the buck,” such as the Making Work Pay tax cut that President-elect Obama has proposed.


    I say, give the EMPLOYEES a two month payroll tax holiday on their share of the tax, but do it according to Obama's "Making Work Pay" method, to pump the money back into the economy, not wealthy savings that aren't even creating small business loans.

    http://www.cbpp.org/cms/index.cfm?fa=view&id=2264 for the reasons why this would be more effective.

    Then give the EMPLOYERS a tax holiday every other month for the next year, based upon the ratio of new hires to the existing payroll headcount. For example, if the company increases the payroll headcount by 1%, they earn the payroll holiday for every new hire; by .5%, they earn a holiday for every other new hire at an equal or lesser pay rate.

    For companies who increase payroll by 4, 5 or 6%, they should get the payroll holiday for a matching number of positions at the same or lower pay rate than the new hire. That is, for a payroll increase of 5%, the employer gets the payroll holiday for each new hire plus 4 existing employees at the same or lower pay scale.

    As they continue to hire, their tax savings in the remaining months increase, but they are not retroactive and the program ends in a year, encouraging corporations sitting on huge piles of cash to hire soon and often.

    By basing it on an increased head count, those hired as replacements do not unjustifiably trigger the tax holiday. Also, this method of scaling the benefit is fair to all sizes of employers.

    By all means, let the Bush tax cuts expire for those earning $250K or more. 70% of Americans support this. Only 3% of those incomes belong to small business owners. So the argument that it will stifle job creation is DOA. Any taxes saved by the wealthy do little to stimulate commerce, compared to the average wage earner. They just go into savings, and the banks aren't even using them for small business loans. The average wage earner spends the majority of every additional dollar earned.

    Eliminate tax cuts and loopholes for oil companies, unless they are investing in new forms of renewable energy. We don't need to grow our dependence upon oil; we need to replace it. Use the taxes recouped from both of these to fund the tax holidays and programs to enable local banks to loosen up the tight credit for small businesses.

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  8. Oops, I didn't think it had been accepted... kept getting an error message about the URI(comment.g) being too long. Sorry for the duplicate post.

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