Potential Economic Impacts of the Payroll Tax Cut Unclear

Shocking as it may be, congress is engaged in yet another bitterly divisive partisan battle. At stake this time? How to pay for a potential extension of payroll tax cuts passed with bipartisan support last year. While leaders of both parties have voiced support for the extension, whether to pay for it through a new surtax on the wealthy or through cuts to medicare premiums and a freeze on federal hiring is the debate preventing any real movement on the issue. As both sides dig in for a protracted political battle, whether or not the payroll tax cut is actually effective economic stimulus becomes a much more interesting question.

Cash on Hand

On a base level, the thought process behind the potential economic stimulation of a payroll tax cut is pretty simple. Americans of every class would pay lower taxes, giving them more money to spend and injecting capital into the economy. What’s more, it would reduce the cost to employers for hiring new employees, and therefore hypothetically increase hiring as well. A September report from the liberal-leaning Center on Budget and Policy Priorities was firmly in favor of extending the cuts for just these reasons. Stating that the tax cuts are worth $934 to the average American family, the Center pointed out that 121 million American families were increasing their paychecks by an average of 1.7 percent because of the cut. The report goes on to cite analysts at Moody’s Analytics who stated that “If [the temporary payroll tax cut and extended federal unemployment benefits] are not extended, real GDP growth will be nearly a percentage point slower in 2012 and there will be approximately one million fewer jobs by year’s end,” and “failure to extend the payroll tax cut is a significant downside risk to the outlook for U.S. growth.”

“I’m Sorry, I Could Have Sworn I Just Heard You Say You Agreed…”

The strategy has relatively few opponents on either side of the aisle, with the only disagreement coming over how to pay for the cut. The fact that President Obama and congressional leaders from both parties all seem to be in agreement on anything should likely be viewed as a small miracle, so that would mean that the benefits of extending the cut are so obvious that they can’t be missed, right? Democratic Sentors Joe Manchin of West Virginia and Jon Tester of Montana, though, broke with the leadership of their party and the opposition by voting against bringing the bill to a vote last Friday. “I do not believe this particular proposal will create jobs or give our economy the boost it needs right now,” Tester said.

What the what?! Both parties in congress agree on something and it might not even work?! Unfortunately, a number of prominent voices are suggesting just that. In an op-ed for the New York Times in late August, expert Bruce Bartlett laid out several reasons why the economic benefits of an extension to the payroll tax cut may not be worth the cost. First, the tax cuts would only benefit those Americans who are employed. A cash influx for low income Americans would most likely be spent immediately, but a large chunk of the population (8.6 percent at last count) wouldn’t benefit at all. Secondly, the indiscriminate nature of the cuts would mean that much of the money would go to Americans who wouldn’t need it and would simply save the short term windfall. Thirdly, evidence points to a tendency by Americans to save short-term tax rebates rather than spending them. And finally, Bartlett asserted that the lack of hiring in the economy is being motivated by factors other than labor costs. Finally, Bartlett points out that cuts to social security taxes, which pay for the program most working people will rely on in their old age, could simply be a zero-sum game in the end.

Dissenting Voices Drowned Out by Political Rhetoric

Bartett’s article (which in retrospect borders on eerily prescient) is not the only one pointing out the potential flaws of a payroll tax cut extension as economic stimulus. Andrew Biggs, a resident scholar at the conservative-leaning American Enterprise Institute is on the same wavelength as Barlett. “People don’t generally respond well to temporary tax cuts so it’s unlikely you’re going to see a strong economic response,” he said . “This really isn’t a left-right issue, it’s just a question of how big an effect you think it’ll have and weather the stimulative effect is worth the cost. My guess is that it isn’t.” David Kautter, who is managing director of the Kogod Tax Center at American University in Washington, D.C. expressed similar sentiments, saying “I think that the economy is so fragile and the recovery is so weak that if the payroll tax is allowed to expire, you’d end up reducing money in consumer’s pockets and that would end up reducing demand.” In fact, a 2009 report by the very Center on Budget and Policy Priorities that touted the cuts above also expressed skepticism about the effects of a payroll tax cut (when Senator Mitch McConnell was championing them, it should be noted):  “A payroll tax holiday, however, would both be costly — a two-month suspension could cost about $120 billion, for example — and likely relatively ineffective as a stimulus measure.  Public resources would be better spent on stimulus measures with a higher ‘bang for the buck’…”

It’s probably doesn’t take a crystal ball to see that there’s a real chance that divisive partisan rhetoric will dominate the discussion over extending the tax cut, and the potential for political inaction to doom a succession no matter how many politicians support it is very real. While the economy’s need for real job growth is high, at this point, it’s entirely possible that the actual economics and policy questions have become largely irrelevant in the face of a looming election year. “…economic analysis is not what is driving the Social Security tax debate,” said Bartlett. “Democrats are using the issue mainly as a political ploy. They may also think that some sort of tax cut is the only additional fiscal stimulus Republicans might possibly support. …Republican opposition to extending the payroll tax cut may represent little more than knee-jerk opposition to any Democratic initiative…”