Right Cut, Wrong Side: Obama Botches the Payroll Tax Holiday
By Bryan Caplan
With perfectly flexible wages, it doesn’t matter whether tax law says “employees pay” or “employers pay.” Tax incidence depends on supply and demand elasticity, not legislative intent. If wages are nominally rigid, however, the law matters. If you cut a tax on employers, this reduces labor costs, increases the quantity of labor demanded, and reduces surplus labor. If you cut a tax on employees, in contrast, this increases worker compensation, increases the quantity of labor supplied, and increases surplus labor.
In both cases, admittedly, a tax cut might directly increase demand and, with nominal wage rigidity, increase employment. But when you cut taxes on employers, the incentive effect and the fiscal effect work in the same direction. When you cut taxes on employees, the incentive effect and the fiscal effect work in opposite directions.
That’s why 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:
The payroll-tax reduction under discussion now would cut the 6.2%
Social Security tax levied on a worker’s wages to 4.2%. A worker making
$40,000 a year would save $800, and some economists say that could help
stimulate demand at a time when the economy remains relatively weak.
The employer’s half of the tax–also 6.2%–wouldn’t be affected under the
White House proposal, and thus the cost of hiring new workers wouldn’t
be directly affected.
Of course, if Obama’s goal is simply to salvage his fading popularity, he’s right on target.
P.S. If you object that you want to put the money into the hands of
people who will actually spend it, remember that cash flow is a good predictor of business spending.
HT: Alex Tabarrok