For Ailing Economy, Cutting Employer Payroll Tax Is Weak Sauce

Last Updated Jun 9, 2011 2:58 PM EDT

The Obama administration is weighing whether to goose the sluggish economy by cutting employer payroll taxes. Politically, it's a long shot. Republicans are clearly hellbent on reducing the deficit, no matter the consequences, with more than 100 GOP House members pushing for a whopping $380 billion in spending cuts in fiscal 2012 alone. (Hey, while they're at it, why not ask Anton Chigurh what he can do to spur growth?)

Since miracles do happen, however, let's imagine that Congress actually goes for it. Is reducing the employer side of payroll taxes an effective stimulus measure? The answer, as usual, is it depends.

How companies respond to tax cuts
Payroll taxes are used to fund Social Security, with businesses and employees each contributing 6.2 percent of a worker's annual compensation (up to $106,800 as of 2010). Lowering those taxes would reduce a company's costs, which should boost hiring and increase industrial production.

The Congressional Budget Office estimated last year that reducing employers' payroll taxes would boost GDP between 2010 and 2015 by 0.4 to 1.2 percent. A Deutsche Bank Securities analysis puts the growth bump at 0.7 percent. Significant, in other words, but ultimately not the kind of high-voltage jolt the economy needs to start minting jobs.

From a political perspective, however, the benefit would likely be immediate. That makes this approach an attractive option for an administration desperate to show that the economy is, as it claims, on the mend.

A key question in figuring out if curbing payroll taxes would improve job-creation is how employers respond to such a cut. As CBO director Doug Elmendorf explained to lawmakers earlier this year, companies typically respond in one of four ways:

  • Some businesses would respond to lower employment costs by cutting prices in order to sell more goods and services. Higher sales would boost production, requiring employees to work longer hours and, in time, inducing employers to add staff.
  • Some businesses would pass the tax savings on to employees as higher wages. That, in turn, could increase consumption by encouraging higher spending. By contrast, a smaller payroll tax cut would tend to limit any increase in spending, since workers wouldn't see significantly bigger paychecks.
  • Some businesses would keep the tax savings as profits, lifting public companies' stock prices. That would boost household wealth, also encouraging spending. A kick in corporate earnings also could help the economy by leading employers to buy new equipment and make other business investments.
  • Some businesses would use most of the tax cut to raise pay for existing workers and do minimal additional hiring.
The government would have to structure the tax cut to take these factors into account. For instance, making the payroll tax reduction available only to businesses that add jobs would improve the policy's efficacy. Still, the stimulative effect on the economy would be only marginally greater than an across-the-board cut, according to the CBO.

Businesses are already flush with cash
Felix Salmon previously brought up perhaps the greatest reason to question how much reducing payroll taxes would help the economy: Businesses, especially large employers, are already sitting on mountains of cash:

I certainly can't imagine that a 1-year cut in payroll taxes would incentivize any employer to hire more people. A 2 percent cut in payroll taxes on a worker earning $30,000 a year amounts to a one-off payment of $600: very nice for the worker, but not remotely enough to get the employer to hire someone else. After all, payroll taxes will go back up to their normal levels in 2012.
What offers the biggest short-term bang for the buck when it comes to reviving the economy? Increasing financial assistance to the unemployed (see chart at bottom). No surprise there, since the jobless are the most likely to spend. That would increase growth by an estimated 0.7-1.9 percent. And in fact the White House is also considering extending unemployment insurance, although David Dayen notes that amounts to a continuation of existing benefits rather than a new stimulus.

Since any tax cut would raise the deficit, of course, all of this is moot if congressional Republicans stick to their guns (or, more precisely, go down with the ship). Obama is trying to square the circle. He wants to reduce the debt, which means decreasing spending, and to create jobs, which means increasing spending. Untie that.

The unfortunate reality is that such policies are in all likelihood tepid half-measures. Like the government's 2009 stimulus package, they have more to do with the limitations of present-day politics than with economic necessity.


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    Alain Sherter covers business and economic affairs for CBSNews.com.