Arnold Kling  

Heavyweight Endorsements for Cutting Payroll Taxes

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John Maynard Keynes writes,

So far as employees are concerned, reductions in contributions are more likely to lead to increased expenditure as compared with saving than a reduction in income tax would, and are free from the objection to a reduction in income tax that the wealthier classes would benefit disproportionately. At the same time, the reduction to employers, operating as a mitigation of the costs of production, will come in particularly helpfully in bad times.

This is from a letter written in 1942 to James Meade, who had suggested varying the payroll tax countercyclically. Meade shared the Nobel Prize in 1977.

Thanks to Mario Rizzo for unearthing the correspondence, and thanks to Tyler Cowen for the pointer.

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COMMENTS (7 to date)
spencer writes:

Why not use the Earned Income Credit.

I would feel a lot better about it than a cut in the payroll tax if I did not think all the advocates of a payroll tax cut are just drooling over how in a year or two a payroll tax cut would
allow them to use the resultant social security deficit to argue that social security would have to be cut.

You ought to try to be a little less obvious.

Brian writes:


As I understand it, the point would be to stimulate employment by reducing labor costs. That would have a much more direct effect than an earned income credit increase.

Greg Ransom writes:

Hayek -- who spent a lot of time with Keynes during WWII -- said that Keynes constantly changed his policy recommendations, and his theories supporting his recommendations, as the issue before his changed.

And Keynes told Hayek that he would change his ideas and recommendations again if "the Keynesians" got out of hand, and sent Britain into an inflationary spiral.

Don't look to Keynes for consistent advice.

El Presidente writes:


The logic behind cutting payroll deductions is that it is an immediate decrease in withholdings (increase in take-home pay and retained earnings) rather than an increased refund (or decreased liability) at the end of the year. The first is treated by the individual as an increase in income while the second is treated as an increase in wealth. They are apt to spend more from the former than the latter. I think the striking thing here is that Arnold's proposal is to NOT reduce the employee's contribution. No, he only wants to reduce the employer's contribution because he says that this will restore profitability.

Furthermore, Rizzo hits the nail on the head here:

Forget about the idea of making up for the lowering, for a moment: Does our political system have what it takes to go back to the current rate after a “temporary” decline? I don’t know.

We saw what happened with "temporary" capital gains tax cuts.

The most important part of Keynes' remark is his reasoning, not his conclusion. He says that a reduction in the employee's contribution will stimulate consumption while a reduction in the employer's contribution will stimulate investment and employment. There is no shortage of available investment dollars today. The Fed and Treasury have loaded the inflation gun and cocked the hammer. They won't flow because there is a insufficient income among those with the highest propensity to consume, which means there will be no increased sales and therefore no additional revenue with which to repay investors or to pay wages to workers.

Chmn. Eccles described it like this before the Senate Finance Committee in 1933:

"In the real world, there is no cause nor reason for the unemployment with its resultant destitution and suffering of fully one-third of our entire population. We have all and more of the material wealth which we had at the peak of our prosperity in the year 1929. Our people need and want everything which our abundant facilities and our resources are able to provide for them. The problem of production has been solved, and we need no further capital accumulation for the present which could only be utilized in further increasing our productive facilities or extending further foreign credits. We have a complete economic plant able to supply a superabundance of not only all of the necessities of our people, but the comforts and luxuries as well. Our problem, then, becomes one purely of distribution. This can only be brought about by providing purchasing power sufficiently adequate to enable the people to obtain the consumption goods which we, as a nation, are able to produce. The economic system can serve no other purpose and expect to survive."

Snark writes:

Damn it all! If we could just convince (or coerce) all businesses and consumers to conform to the brilliantly conceived Keynesian model of how the economy works, we could exorcise these animal spirits and get back on the road to El Dorado!

scineram writes:

More like an antiendorsement, if you are a rothbardian.

fundamentalist writes:

As much as I admire Dr. Kling, I think he's wrong on this. Yes, lowering the tax would make labor cheaper, but for how long? Business people aren't coke machines. You can't always put in a dollar and get the drink you want. As human beings they will look at the tax cut, realize that it is a one night stand, not a marriage proposal, and pocket the money without hiring any new workers.

For this tax cut to work, Congress and economists will have to convince businessmen that it is permanent and that will be difficult to do.

Making labor cheaper will help some industries and hurt others. Those industries that are labor intensive, such as restaurants and hotels, may hire more workers, but they tend to be low paying jobs. It won't help with housing because there is a glut of housing on the market. It would make no sense to hire more workers to build more houses. Nor will it help the auto industry.

It won't help manufacturing, either, because manufacturing relies on demand for labor saving equipment. If labor is cheaper, businesses won't buy labor saving equipment but will employ more labor. This is basic, basic micro economics. As a result, the industries hit with the highest levels of unemployment, housing, autos, manufacturing, won't benefit from this tax cut. Labor intensive industries where unemployment is still low will benefit.

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