Jonathan Ortmans, President, Public Forum Institute
Employment in the U.S. has been in a free fall. Payroll employment has declined by 3.6 million since the start of the recession in December 2007, according to the latest report from Bureau of Labor Statistics. Firms have shed jobs every month since January 2008. Last January alone, the national payroll dropped by 598,000 jobs. The unemployment rate has risen from 4.9 percent in January 2008 to 7.6 percent in January 2009. Is it time to consider a payroll tax cut?
When the goal is to contain unemployment, taxing labor does not make much sense. In 2007, IRS collections from FICA (Federal Insurance Contributions Act) taxes totaled $787.8 billion. Firms and households share the burden of these payroll taxes.
An estimate suggests that if Congress cuts workers’ Social Security contributions by 2%, workers earning $20,000 a year would enjoy a tax break of $400, and workers at the taxable maximum ($106,800) would receive $2,136.The concern is, as with any tax break, that a payroll tax cut can be ineffective if households, distressed about the outlook of the economy, save the additional disposable income or use it pay down debt, instead of spending to stimulate the economy.
But a payroll tax cut will not only influence households’ decisions; it will also affect decisions by firms. In general, the tax code is a package of incentives influencing entrepreneurship, including hiring decisions. A reduction in the payroll tax would give firms an incentive to retain more employees on their payroll by reducing the cost of employing workers.
Another caveat is that payroll taxes are one of main sources of revenue for Social Security and Medicare benefits, which already face severe funding problems. However, because these programs are financed out of total government revenues they could continue to receive the same level of funding. The primary goal of tax policy is to raise public revenues to deliver benefits like these, but the structure of taxation also matters. Tax incentives should be crafted to boost economic growth.
In times of sharp economic slowdown, federal tax policy should support entrepreneurship in order to accelerate growth and job creation and retention. The labor market incentives that a payroll tax cut can provide make it an option worth considering to break free from the vicious circle of slumping demand, falling production, reduced investment and rising unemployment.