How Effective Would a Payroll Tax Holiday Be In Spurring Employment and Stimulating the Economy? → Washingtons Blog
How Effective Would a Payroll Tax Holiday Be In Spurring Employment and Stimulating the Economy? - Washingtons Blog

Monday, December 6, 2010

How Effective Would a Payroll Tax Holiday Be In Spurring Employment and Stimulating the Economy?

Obama's tax deal with Republicans extends the Bush tax cuts for the wealthy for another 2 years.

As Bloomberg notes, Obama said that "he still believes the nation can’t afford to permanently extend the top tax rates".

But as Mish points out:

Of course the last extension was "temporary" and the next extension will be "temporary" as well.

Obama's plan would also extend aid for the long-term unemployed for another 13 months.

And the payroll tax (which funds Social Security and Medicare) would be cut by 2 percentage points during 2011 in an effort to help spur hiring.

Will cutting the payroll tax really help to spur hiring?

The Center on Budget and Policy Priorities argued in January 2009 that it wouldn't.

Suspending employees’ payroll taxes would immediately translate into higher take-home pay for workers. Suspending employers’ payroll taxes, by contrast, would put cash into companies’ coffers, where it is likely to sit as long as sales are weak and factories are operating below full capacity. Indeed, according to the Congressional Budget Office [here's the CBO report], suspending employer’s payroll taxes is “not a particularly cost-effective method of stimulating business spending: Increasing the after-tax income of businesses typically does not create an incentive for them to spend more on labor or to produce more, because production depends on the ability to sell output”. In other words, firms will not hire (or retain) more workers than it takes them to produce the goods and services they can sell. Simply giving them a general tax break is unlikely to affect their hiring or investment in most cases, and thus would be largely ineffective as stimulus.

Standard economic analysis suggests that over the long run, a permanent reduction in the employer payroll tax would increase wages, as competition forced employers to pass on the benefits of the tax cut to their workers. But a two-month holiday on the employer share of the payroll tax would not have that effect: according to the Congressional Budget Office, “[s]uspending the employers’ portion of the tax for a short period of time is unlikely to alter wage rates by very much and so would not alter consumers’ resources very much.” Firms generally would not raise wages for two months and then cut them, and the reduction in wage costs would be too brief to make it worthwhile for employers to increase hiring. Instead, businesses would likely retain all or nearly all of the benefits from the tax holiday.

Would infusing cash into businesses in this manner constitute effective stimulus? Probably not. The primary problem that employers face in a recession is a shortage of demand for their products, not a shortage of cash. Therefore, most firms would likely keep much or all of any tax windfall they receive — or pass it on to shareholders and business owners, two groups that tend to have higher incomes and thus quickly spend relatively little of any additional income they receive.


The Urban-Brookings Tax Policy Center estimated that in 2006, 51.2 percent of payroll taxes were paid by the top 20 percent of tax units.

(Obama is proposing a year-long payroll tax holiday, not the 2 months discussed by CBPP. I'm not sure how much difference CBPP would find in an additional 10 months).

But as Annie Lowrie noted in September:

The Congressional Budget Office examined (PDF) the effectiveness of a variety of tax cuts this winter [in an updated report], and found payroll tax cuts to be a good option, compared with, say, extending tax cuts for the wealthiest Americans. Moreover, they have positive impacts on employment — and the sustained high rate of joblessness remains the biggest drag on the American economy and a pressing public-policy issue.

According to the CBO, a payroll tax cut is about 25 to 33 percent more stimulative than providing a refundable tax credit for lower- and middle-income households, for instance.

As I noted in 2008, Mark Zandi - chief economist for Moody's - calculated which stimulus programs give the most bang for the buck in terms of the economy:

Zandi lists a cut in payroll taxes as being less stimulating to the economy than food stamps, unemployment benefits (which Obama extended), infrastructure, and aid to the states, but more stimulating than tax cuts and tax rebates.

The Washington Post's Ezra Klein turned to Zandi in July for updated figures on the effects of a payroll tax holiday:

Zandi's most recent number estimate of the per-dollar economic impact of a payroll tax holiday is $1.24. This is a relatively high figure, but there are a number of better options, including expanding food stamps, work share programs, direct aid to states and a jobs tax credit.

Klein ran a back-of-the-envelope cost-versus-benefit analysis of a partial payroll tax:

As Zandi's numbers suggest, the stimulative benefit is just slightly greater than the budgetary cost.


With better options, such as work sharing or food stamps expansion, available, it's not clear to me that the focus should be on payroll tax relief.

And see this.


  1. Bang per buck calculations are badly flawed, if not meaningless, and for the following reasons. Given a relatively low bang per buck (e.g. an employer payroll tax reduction) much of the money appears to be wasted in that employers tend to hoard the money (as you rightly point out).

    However, the money that needs to be shovelled into employers’ pockets to induce them to do anything is NOT A REAL COST, or at least it needn’t be. In contrast, any jobs created ARE A REAL BENEFIT. Thus the above cost – benefit analysis does not compare like with like.

    To expand on that, the money that needs to be shovelled into employers’ pockets can perfectly well be created out of thin air. (The Fed created £3.3 trillion out of thin air to help banks around two years ago, according to Bloomberg, and is currently making this money disappear in a puff of smoke as banks repay it.)

    Incidentally, I’m not ADVOCATING an employer payroll tax reduction: an EMPLOYEE tax reduction would be better. I’m just using the former as an illustraton.

    But the above points are ten miles above the heads of politicians (and probably most economists). Hopefully in a hundred year’s time, if economics advances, politicians might understand the above points. But for the moment we have to run the economy on the basis of Neanderthal economics: hence the continued recession.

  2. Use it or lose it, is the principle of progressive taxation. It is economically stimulative and will raise tax revenues. It is not even discussed in the current "dialogue" because it contradicts the defend the wealthy corporatists at all costs perspective.

    When taxed at progressively higher rates, the rich and corporations will invest their money in tangible capital enterprises. They will do this to seek out business tax deductions and business investment tax credits. They will seek out investments in depreciable assets. Payroll is tax deductible, this is why employment rises during periods of higher taxation but decreases or is anemic during periods of tax decreases. When taxes are progressively increased on the rich, their capital business investments nullify the higher marginal rates while increasing tax revenues in the agregate by generating commerce, higher employment and real productivity.

    When you don't tax the rich they merely engage in hoarding and speculation because there is no incentive not to do.

  3. How silly!

    Everyone is for less taxes, but you don't get less taxes with payroll tax cuts.

    What you get is more regressive inflation (which is just another kind of tax) -because the government will just print the money to make up for the loss in tax revenue.

    Supply side economics is a fantasy propounded by banking interests that just love to make money loaning the government money by buying bonds with money they borrow from the Fed.

    There are no REAL economists any more.

    There are just Princeton flunkies and wanna-bee flunkies from the Mises Institute.

    Oh God, DUCK! Here come the arguments that stimulus of some sort is necessary.

  4. INFRASTRUCTURE is the best way because it creates value that supports all the money printed to pay for it (as B. Franklin said: "...backs the paper money as certainly as gold or silver...") and so an unlimited amount of money can be printed to put 100% of the people back to work.

    I would suggest $13Trillion for High Speed Rail and a Rail Land Bridge from Alaska to Russia as a first step to building a world wide high speed rail system.

  5. Economist! Blaa! Sheep blaaa!
    The cause of most of the small businesses going out of business at the beginning of the Depression was that gasoline jumped from $2.50 a gallon to $5.00 a gallon. Big Oil set records with billions in profit and American local businesses and the citizens paid the price with many going bankrupt. The increase in oil prices was the primary reason most of the small businesses folded at the beginning of the recession.

    Mainstream Economist or politicians will not mention the fact that if Big Oil goes on another profit lust, which they certainly will, and blast the price of gasoline to $5.00 or more, all of their bullshit tax cuts and stimulus comes to nothing more than being a subsidy for Big Oil price hikes.

    Not one dime in tax is levied on Wall Street’s $400 trillion derivatives market or on the banister’s obscene profits. The rest of the world is indebted to them right?

    Socialism for the 1% rich and capitalism for the poor! Americans are fools led by fools!

    What is so outrageously revolutionary about the idea of collecting tax on those who are most able to pay?


→ Thank you for contributing to the conversation by commenting. We try to read all of the comments (but don't always have the time).

→ If you write a long comment, please use paragraph breaks. Otherwise, no one will read it. Many people still won't read it, so shorter is usually better (but it's your choice).

→ The following types of comments will be deleted if we happen to see them:

-- Comments that criticize any class of people as a whole, especially when based on an attribute they don't have control over

-- Comments that explicitly call for violence

→ Because we do not read all of the comments, I am not responsible for any unlawful or distasteful comments.