Economists Disagree on Effectiveness of Payroll Tax Holiday for Businesses

President Obama’s American Jobs Act, in addition to proposing an expansion of the payroll tax holiday for workers, includes two provisions that would reduce or eliminate employers’ payroll tax contributions in 2012.

Compared to the proposed employee-side payroll tax holiday, there is less of a consensus among mainstream economists that a payroll tax holiday on the employer side would provide a boost to the national economy.

The first employer-side provision would cut all employers’ payroll tax contribution in half (from 6.2 percent of wages to 3.1 percent) for their employees’ taxable wage and salary income up to $5 million.  The second provision would temporarily eliminate employers’ payroll tax contribution for each additional employee hired and for wage increases for current workers.  Expanding businesses would be able to claim the full payroll tax holiday for up to $50 million in new wages paid to employees.

According to the economists at the non-partisan Congressional Budget Office (CBO), there are four avenues through which a payroll tax holiday for employers could increase output and create jobs:

  1. Businesses could use the payroll tax holiday to temporarily boost the wages of employees, boosting their purchasing power (similar to the impact of the employee-side payroll tax holiday).
  2. Businesses could retain the tax savings as higher profits, increasing the income of owners and shareholders, some of which is likely to translate into increased consumer spending.
  3. Some businesses may take advantage of temporarily lower employment costs to hire additional workers.
  4. Businesses could translate lower payroll costs into lower prices, thereby increasing sales and output.

Based on the multitude of channels through which an employer-side payroll tax could boost the economy, the CBO estimates that this employer-side payroll tax holiday would be even more cost effective for creating jobs than providing a direct payroll tax to employees.  In fact, the CBO projects that a broad-based employer-side payroll tax holiday would create between 5 and 13 jobs for each $1 million in budgetary cost.  For the full payroll tax holiday aimed only at expanding businesses, the CBO-estimated cost effectiveness rises to between 8 and 18 jobs per $1 million cost.  For the employee-side payroll tax holiday, the CBO estimates a much lower cost effectiveness – only 3 to 9 jobs per $1 million cost.

Other economists are significantly less bullish on the effectiveness of an employer-side payroll tax holiday, particularly one not focused on expanding businesses.  Economist Mark Zandi scores the employee- and employer-side payroll tax holidays about evenly in terms of cost per job created, but other economists, notably respected tax expert Len Burman and Lawrence Mishel, have noted that cutting taxes on businesses, particularly large corporations sitting on substantial piles of cash while not hiring new workers, are unlikely to respond to even more cash through hiring or reducing the prices of products and services.

Even Reagan economic adviser Bruce Bartlett has advocated direct spending on public works to create jobs for the millions of Americans seeking work rather than indirect spending through tax cuts that may or may not benefit those most in need of work and income.

President Obama’s proposed employer-side payroll tax holiday is designed to target most of the benefits to small- and medium-sized businesses, but the difficulty of predicting how businesses will respond to increased cash at a time of severely depressed demand for goods and services raises considerable uncertainty about the effectiveness of an employer-side payroll tax holiday.

2 Comments

  1. Eunice

    September 27, 2011 at 10:21 am

    Isn’t all of this just borrowed money that will increase our deficits ? The payroll tax deal simply steals money from the Social Security fund. Instead of just short term chicanery, why doesn’t Obama quit holding all of these trade agreements ?

  2. [...] The Progressive Pulse runs down arguments for and against a payroll tax holiday. [...]