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Magazine / NEED TO KNOW: BUDGET

The Small-Bore Solution

Extending the payroll-tax cut beyond 2012 is an anchor of Obama’s jobs plan. Good luck with that.

Payroll tax break: “Honey, what should we do with this?”(SuperStock)

photo of Nancy Cook
September 8, 2011

This year, the take-home pay for a middle-class worker will rise by as much as $2,200. For two-income families, that boon totals as much as $4,400. What politician would want to take that away and be accused of raising taxes on average, hard-working people at a time of high unemployment?

Certainly not President Obama, who has spent the last few weeks extolling the virtues of the payroll-tax holiday as part of his new job-creation package.

The payroll-tax break, enacted in early January, temporarily lowered the share of income that employees contribute to Social Security from 6.2 percent to 4.2 percent. For self-employed workers, that share fell from 12.4 percent to 10.4 percent.

 

Putting extra money in the pocket of workers sounds like a logical move, yet there’s little evidence that the payroll-tax break has helped stimulate the economy by encouraging consumer spending. The tax cut did not go to the unemployed, the people who most need a financial cut and would be most likely to spend it. The program’s estimated $120 billion price tag was funded by money from the Social Security trust fund, money that will soon be badly needed as more and more baby boomers hit retirement age. And if the federal government and Congress extend the payroll-tax holiday by an additional year, deficit hawks worry that the tax break will become permanent—just another sacred giveaway with a mixed record that adds to the nation’s ballooning deficit.

“It doesn’t do much for long-term unemployment, and it’s not clear it stimulates economic activity as much as government spending on infrastructure,” says Alan Auerbach, an economics professor at the University of California (Berkeley). “The question is: Should we do that or nothing at all?”

Historically, tax breaks and rebates work best when individual households believe the breaks are permanent or, at least, long-term. In a 2009 research paper, Auerbach and William Gale, a senior fellow at the Brookings Institution, studied the effects of the 1975 income-tax rebate, which, a month after its enactment, pumped  into the economy only between 12 percent and 24 percent of its value—hardly an earth-shattering binge of consumer spending.

In studying the Bush tax cuts of 2001, Auerbach and Gale also found that the more income and liquid assets people had, the less likely they were to spend their windfalls. Instead, they tended to either save the money or use it to pay down debt—another blow to the argument for extending the tax holiday to middle-income earners. The nonpartisan Congressional Budget Office had predicted as much in January 2010, writing that the “majority of the take-home pay would be saved rather than spent.”

“I’m not sure there’s a big enough bang for the buck there,” says Robert Bixby, a self-proclaimed deficit hawk and the executive director of the Concord Coalition, a nonpartisan policy organization focused on fiscal responsibility.

But the question of getting bang for the buck depends on one’s long-term view of the best way to boost the economy. Economists such as Mark Zandi of Moody’s Analytics argue in favor of the extension of the payroll-tax cut as way to create jobs. The logic goes: Even though some people will save their tax breaks, they will still increase spending and should spur job creation. In a policy paper published in late August, Zandi predicts that failing to extend the payroll-tax holiday through 2012 could slow GDP growth by nearly an entire percentage point and that the economy would generate roughly 1 million fewer jobs by the year’s end.

If job creation is the main goal of the payroll-tax holiday, though, the estimated $120 billion (perhaps combined with the revenues from letting some of the Bush-era tax cuts expire) could fund more-substantial stimulus programs than a tax holiday. What about direct aid for the unemployed, perhaps through health care insurance subsidies? Or, what about listening to the conventional wisdom of economists, and of the U.S. Chamber of Commerce, and put that money into infrastructure construction, which would put people to work repairing roads and bridges?

The lure of the payroll-tax holiday seems so seductive. It makes the politicians who enacted the law seem sympathetic to the plight of everyday workers, and it puts money into the pockets of people quickly, regardless of how they use it.

But at a moment when all entitlement programs are under attack, the president and Congress might want to pause and ponder before extending the payroll-tax holiday. Ending the tax break, as politically unpopular as it sounds, would preserve much-needed cash in the Social Security trust fund and slow the government’s hemorrhage of revenue.

Finally, its expiration would stop political leaders from engaging in what Bixby calls small-bore thinking: assuming that a few billion dollars here or there can solve the much larger challenges of reviving the economy, controlling spending, and reducing the nation’s long-term deficit.

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