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.