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Think Twice - A Holiday to Help the Economy

By suspending the payroll tax, we help lower-income employees as much as we help higher-income employees.

June 20, 2002
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Would declaring another national holiday help the American economy? What if it's a month long holiday?

It might help if it's a "payroll-tax holiday." Under this plan, employers and employees would each not have to pay Social Security payroll taxes for a given period of time. We could party for a while -- perhaps a month -- to help end the recession.

Social Security would be unaffected. The government would just take the amount of money that the payroll taxes would have contributed to the Social Security system and send a check to the Social Security Trust Fund for that amount instead.

Why might this work as an alternative to the many other economic-stimulus ideas floating around in Washington, D.C.?

  • Unlike other proposals, it actually offers an incentive for employers to hire more people. Let's say we suspended both the employer's share and the employee's share -- 6.2 percent each -- of the Social Security tax for a month. It would be cheaper for businesses to hire new employees. If you decrease the price of something, in this case labor, people can buy more of it. The holiday would also apply to current employees, thus reducing the financial savings of a downsizing.

    In contrast, some Republicans in Washington want to try to stimulate the economy by giving tax breaks to corporations for expensing of equipment and building purchases. What a waste. Businesses like Intel already have buildings going unused and excess inventory that isn't being purchased. A tax break for expenses would just provide more money for excess inventory and space.

  • It's a better idea than sending people an income-tax rebate in the mail. Professors Matthew D. Shapiro and Joel Slemrod of the University of Michigan studied what happened when Americans got income-tax rebates last fall of $300 or $600 as part of a tax cut that totaled $38 billion. The profs found that the rebate led only 22 percent of households to spend more. In other words, if the tax rebate was supposed to jump-start consumer spending and thus the economy, it didn't do diddly. Another survey after the September 11 triple terrorist attacks showed that another tax rebate would do about the same thing.

    Senate Budget Committee member Pete Domenici, who supports a payroll-tax holiday, explained the Michigan findings in a statement that was right on the nose. "When workers get a separate rebate check, they are more likely to treat it as a special windfall gain and save the money or pay down debt," says Domenici, a moderate from New Mexico. "Psychologically, workers are used to adjusting their spending habits based on the size of their paychecks."

  • It doesn't favor the rich. The payroll tax is not progressive. By suspending it, we help lower-income employees as much as we help higher-income employees. A payroll tax cut of 6.2 percent to someone earning $40,000 a year is significant -- about $200 for the month. If that employee worked for herself, thus paying both the employer's portion and the employee's portion of the payroll tax, you're talking about a savings of about $400 for the month.

What's the drawback of a payroll-tax holiday? Well, like anything that sounds good, it ain't free. Domenici estimates that if it were done for the month of January, for instance, it would cost about $43 billion. This would take money away from other initiatives in Congress that are supposed to get us out of the recession. However, many of these plans involve spending on pet projects in the districts of powerful legislators. These aren't necessarily the best thing to stimulate the country's economy. It could also take money away from other tax-cut proposals that are floating around, including cuts in the capital-gains tax or corporate income tax reductions.

If you cut income taxes, it may not kick in until April. That doesn't do a whole lot of good when you're out of work right now. The Business Roundtable, an association of 150 CEOs employing 12 million people and generating $3.5 trillion in revenue, agrees. "The goal is to have an immediate impact," says spokesman John Schachter. "A cut in the payroll tax would do that. It's a cut for both the employer and the employee, and we certainly support that concept."

So would many people who want to get back in the workforce. A payroll tax cut would help them, and make for a heckuva holiday to begin the year.

Workforce, January 2002, p. 88 -- Subscribe Now!

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