Bryan Caplan  

The Missed Opportunity of the Payroll Tax Cut

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My Segment on Stossel... The Great Debate...
Yesterday, while reviewing my tax withholdings, I noticed a weird anomaly.  In 2011, for the first time in my life, my employer was paying more Social Security taxes than I was.  I furrowed my brow until I remembered this earlier post:
Obama's proposed payroll tax holiday botches an idea of truly Singaporean cleverness.  Instead of giving the tax cut to employers, where it would do the maximum good, or splitting it evenly, where it would do intermediate good, he's giving all of it to employees, where it does the minimum good...
I admit that I may be unusually clueless about my income.  I further admit that workers don't have to notice a tax cut to respond to the higher income it generates.  But I still have to insist that tax cuts are more likely to change behavior if they're widely noticed - and Obama's payroll tax cut doesn't qualify. 

Would employers have been any more responsive?  It's hard to prove, but still highly plausible.  Would employers, long stereotyped as money-grubbing bean-counters, really have taken my ten months to notice that their labor costs were 2% lower?  If you're still skeptical, put yourself in the shoes of an employer who spends 70% of his expenses on labor and earns a 5% return.  All else equal, a 2% reduction in his labor costs implies 30% higher profits.  Sounds like a great time to expand his business.


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COMMENTS (19 to date)
nazgulnarsil writes:

Employees get a temporary tax cut. Expect compensation to respond inversely to restore equilibrium. Wages are sticky so I expect the longer term effect of lowered raises.

Alex Godofsky writes:

Employer-side payroll tax cuts are particularly good stimulus in a world of sticky downward nominal wages. So of course Obama won't do that.

Brandon Berg writes:

If you understand politicians' priorities, it's clear that it's not a wasted opportunity at all. An employer-side payroll tax cut would have been a waste of a perfectly good opportunity to pander to voters.

Joe Cushing writes:

I agree with Brandon. The problem with democracy is that you have to educate everyone to get outcomes that are good for them. I realize that's what you are trying to do here but the average person isn't reading your blog.

BBK writes:

Except if it's that 2% payroll tax cut that makes the marginal difference in profitability to justify a new hire, you, as the business owner, know that it's time limited. As such, your expectations as an employer are that come 2012, the conditions under which it 'wasn't worth it' to hire that employee return.

Now your stuck with someone who isn't worth it, and your left with two bad options:
- keeping them on and losing money on them in hopes that the political regime will extend the tax break or,
- can them and get stuck paying increased unemployment taxes for years to come as a result.

While I agree with you that the tax cut would be 'good' in principle, long tax reform, or even just long term expectations of political stability/lack of change in red-tape and costs businesses are burdened with by the regime in Washington, would go much further to spur new hiring and economic growth than continued short term shell game shenanigans.

[N.B. This commenter, BBK, posts occasional comments under varying nicks such as ZC and Joe. He has been informed that posting comments under a new nick every time is problematic on EconLog. Perhaps some people just forget the nicks they previously used or are known by, eh?--Econlib Ed.]

Chris writes:

Brandon and Joe: If Bryan is correct, incumbent politicians face a tradeoff between (1) winning political points now with an employee-side tax cut and (2) a higher chance of reelection in the future because unemployment is lower. Depending on term lengths, distribution of power, and so on, it could be that a majority of incumbents prefer (2), and this does not depend on voters' knowledge about the issue.

Blake writes:

Or you can live in Illinois where our income taxes were raised the same amount as the payroll tax cut so no one would notice sees that actual tax increases in their checks until the payroll holiday is over.

jb writes:

Even if the tax rebate was time limited, there are businesses that would have accelerated existing hiring, or used the extra money for one-time project work, or equipment purchases, etc.

Telnar writes:

Greg Mankiw's model where some consumers are credit constrained and live paycheck to paycheck and others have non-trivial savings implies some stimulus effect since while Brian won't notice the change (since the tax cut initially only alters his savings rate, not any short term variable), those previously spending their full paychecks will now have new options.

I agree that doing this on the employer side would be better, but the actual plan isn't quite as ineffective as it looks from a saver's perspective.

Lord writes:

Because there is so much demand out there to fill? Employers would notice that it is temporary and expansion is unneeded and would do .. nothing. Not noticing may even be more effective as many spend whatever they take home. Sneaky but clever.

Ted Craig writes:

Nobody noticed the payroll cut because we've had strong inflation this year, even though economists insist we've had none. Healthcare costs continue to rise while wages are stagnant, so take-home pay decreased for most people even with the cut. Also, everyday costs such as food and fuel have gone up.

Glen writes:

Why would employers use these profits to invest in business expansion when their best option is to invest in things that reduce costs? In most businesses I know of, its you employees that cost the most. Temporary payroll cuts expect the recipient to act like the restaurant that saw a revenue increase when the circus came to town by expanding their business. Smart businessmen know that the increase is because of a temporary event and would use any profits to figure out how to do more with less. Employees are much more likely not be concerned about the temporary nature (or that there will be no long term effect) and act accordingly.

ColoComment writes:

No one's yet mentioned that it's the payroll tax that funds current SS payouts, and if you decrease the $$ being collected on a current basis, you still have to fund the payouts. Which will have to come from, where? General funds? Of which 40 cents of every dollar is borrowed (at least, that's what "they" say). So, really, what is gained here?

THERE IS NO FREE LUNCH.

A costly stimulus by any other name still has to be paid for, and a costly stimulus that is not even noticed is doubly useless.

fender writes:

http://online.wsj.com/article/SB10001424052970203752604576641133332697322.html so maybe there's bigger nurturing effect than you thought?

Wouldn't employers notice that the tax was cut on the employee side and factor that in when the topic of raises comes up?

Charles R. Williams writes:

The big problem with giving the tax cut to employees is that it does nothing to cut compensation costs for workers at the minimum wage level. The soaring minimum wage combined with the perverse structure of Obamacare have made an increasing percentage of the workforce unemployable - at least in the above-ground economy.

Steve Roth writes:

Yes, salience matters. There's good literature demonstrating it.

But:

1. Corporate profits have been rockin', but hiring remains weak.

2. Meanwhile, businesses continue to increase their investments in equipment and software:

http://www.asymptosis.com/wp-content/uploads/2011/10/FigureA.png

3. You are correct that you're not representative. You love your work and are well paid for it; marginal differences in pay (as shown by your ten months) have little effect on your behavior. To what extent are these things true of people in the middle of the income bell curve?

4. Unlike you (or employers with profits), those typical workers are far more likely to change their spending behavior, revealing their preferences and using the wisdom of the crowds to provide demand for goods and enterprises that people actually want -- in the process funding Arnold's PSST shifts.

roystgnr writes:

The rational thing for employers or employees to do in response to a temporary tax cut is save that money to prepare for the inevitable subsequent compensating tax increase. Or, with today's politics, to over-save, because nobody powerful has a plan other than "hope this will all blow over before the federal debt bubble pops" and so nobody powerless can have a plan better than "hunker down for the worst case scenario if/when the federal debt bubble pops".

Noah Yetter writes:

One thing's for sure, Obama failed to take any credit for this tax cut, however small and temporary it may be. I remember the first paycheck that I got which reflected the cut puzzled me greatly, particularly because no one -- including my company's HR department -- could tell me why that check was bigger than the one before it. I only figured it out by googling.

I bet if you polled people at random you'd find very few that credit Obama for that boost to their paychecks, as well as a good number who, like Bryan, didn't even notice.

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