Tuesday, August 30, 2011

Bartlett on the payroll tax cut: a tax cut conservatives don’t like

Writing for the New York Times, Bruce Bartlett discusses the debate over cutting the payroll tax as a means to stimulate the economy:

Many leading Republicans, it seems, are extremely cool to the idea of extending the temporary cut in the Social Security tax that took effect on Jan. 1 and expires on Dec. 31. It has lowered employees' share of the payroll tax to 4.2 percent, from 6.2 percent.

In theory, the payroll tax cut has positive economic effects on both the demand side and the supply side. By increasing workers' cash flow, it should encourage additional spending in the economy – something that the economy desperately needs.

It also reduces the tax wedge between what it costs employers to hire a worker and the worker's after-tax reward. Thus, a cut in the payroll tax should increase economic activity and reduce unemployment.

However, there is no evidence that the lower payroll tax has done much of anything to stimulate either spending or hiring. There are a number of reasons for this.

First, the tax cut only helps those with jobs. While many have low wages and undoubtedly are spending all their additional cash flow, those with the greatest need and most likely to spend any additional income are the unemployed.

Second, the payroll tax cut helps many workers who have no need for it and will only pocket the tax savings.

Third, economic theory and the experience with tax rebates in 2001 and 2008 tell us that people are strongly inclined to save temporary increases in income. People only increase their spending when they perceive an increase in their permanent income.

Fourth, even if one assumes that the cost of employment has declined and employers can somehow capture some of the payroll tax cut, there's little sign that labor costs are the principal factor holding back hiring.

I'm one of the conservatives quoted in opposition to the payroll tax cut:

Andrew Biggs of the American Enterprise Institute has said that a temporary payroll tax cut "is a dubious idea that would give low-wage workers a modest temporary boost, but at the expense of the Social Security program they will depend upon in retirement."

And I think that quote was from back when John Kerry was proposing to cut the payroll tax. At least I'm consistent! I just don't see that much additional spending being generated by a payroll tax cut, although I'll be frank and admit that I don't have a much better plan. Once you're in the ditch it's hard to get out – which means that we should pay a lot of attention to learning the correct lessons of how we got where we are.



WilliamLarsen said...

Having studied and modeled social security OASI for more than 30 years, I like the tax cut. The reason is simple; Social Security is a ponzi scheme. For those born prior to 1938 they received very generous benefits in relationship to what they paid. For a person born after 1985, those cohorts can expect to receive just 29 cents in benefits for each dollar paid to SS-OASI plus the interest paid at the US Treasury Rate. In fact you could burn a portion of the tax, bury the rest in the back yard and do as well as SS-OASI is able to pay under current law.

So if I pay less, as young person, I save more. Why contribute a dollar to SS-OASI when it is a negative return? If Social Security were a home, it would be underwater by 90%!!!.

It has assets of $2,7 Trillion and liabilities of over $26 Trillion.

Now I dislike the SS tax cut because General Revenues are being used to pay SS for taxes that are not being paid by the worker. This to me violates Federal Statute United States Code Title 42, Chapter7, Subchapter VII, Sec. 911 (a)

Federal Law prohibits transferring general revenues to any trust fund.


If you want the truth about Social Security, I would suggest this link.


Arne said...

"For a person born after 1985, those cohorts can expect to receive just 29 cents in benefits for each dollar paid to SS-OASI plus the interest paid at the US Treasury Rate."

SSA analysis See table B-1.

Mr Larsen is off by a factor of two. Using the trust fund rate is also dubious. From the report: "If a risk-adjusted real interest rate less than about 1.35 percent is deemed appropriate, as suggested by some research,49 then the estimates displayed in Chart 3 indicate that even the most distant birth cohorts are projected to receive their money’s worth from the OASI program under either of the balanced budget
policies considered."

If Congress in the 1950's and 1960's had maintained the TF level of 300 percent that FDR targeted in 1935, this analysis would produce better than TF (US treasury) rates, but even in 1935 the program was primarily pay-as-you-go, so a cash flow analysis that all contributions accrue interest is simply wrong.

There is real benefit now in taking care of the previous generations, so time value of money does not apply.