By Bryan Caplan
With flexible prices, many tax cuts are equivalent to each other. If wages instantly adjust, for example, it doesn’t matter whether you cut the employers’ share of the payroll tax, the employees’ share, or the whole thing. The recipient of the tax cut depends solely on supply and demand elasticities, not the law.
Of course, a key problem with recessions is that many prices aren’t perfectly flexible. That’s why people lose their jobs during downturns, instead of seeing a sudden fall in their wages. The upshot is that during recessions, the legal details of a tax cut temporarily become much more important.
Example: Suppose you cut employees’ share of the payroll tax. With rigid wages, this puts money into workers’ hands, not employers’ hands. But it does nothing to eliminate the labor surplus (a.k.a. “unemployment”). In fact, it makes the labor surplus worse, because more people will want jobs when after-tax wages go up. In contrast, if you cut employers’ share of the payroll tax, this puts money in employers’ hands, not workers’. But the indirect effect is to reduce the labor surplus; employers want to hire more workers (or lay-off fewer) when labor costs are lower.
Does any country actually take advantage of this insight? Sure – Singapore. Who’s next?