Annie Lowrey’s recent piece in the New York Times on the likely year’s end expiration of the 2 percentage-point employee-side payroll tax cut has sparked a welcomed broadening of the discourse over the so-called “fiscal cliff.” The punditry’s discussion of expiring provisions and pending spending cuts has, for months, been overly and narrowly focused on the looming sequestration cuts and expiration of the Bush-era tax cuts while ignoring the single largest pending fiscal headwind: expiration of the remaining ad hoc stimulus.
In our recent paper on the coming fiscal obstacle course (the “fiscal cliff” is a truly terrible metaphor as it implies a binary policy choice), my colleague Josh Bivens and I estimate that—should they all lapse—expiration of the payroll tax cut, emergency unemployment insurance, and recent expansions of refundable tax credits would shave 1.4 percentage points from real GDP growth in 2013 and lower employment by more than 1.6 million jobs, relative to full extension. This is not to suggest that the remaining ad hoc stimulus necessarily be continued in its existing form—the fiscal obstacle course represents an opportunity to fundamentally reorient fiscal policy to be maximally accommodative of growth, and every economic headwind should be examined à la carte on its merits.
Lowrey accurately characterizes our position on the payroll tax cut: An optimal policy response would replace the payroll tax cut with more cost-effective infrastructure investment or aid to state and local governments. (Similarly, restoring the Emergency Unemployment Compensation program to provide up to 99 weeks would be optimal; unemployment benefits yield the highest bang-per-buck of any policy in the fiscal obstacle course bag, and we still face a long-term unemployment crisis in the labor market.) But optimal policy responses are hard to come by these days. Restoring full employment—which should be the top policy objective for our depressed economy—requires measures that would dwarf the Recovery Act, which regrettably seems highly unlikely. Which brings us to political compromise and second best policy responses…
When enacted in late 2010, the payroll tax cut was meant as fiscal stimulus that would be palatable to conservatives as well as liberals—it was, after all, the one piece of fiscal stimulus proposed by the Bipartisan Policy Center’s centrist fiscal plan Restoring America’s Future, and according to Lowrey, it retains support from conservatives at the Heritage Foundation (these think tanks tend to reflect support for various policies in the center and right, respectively). Simply put, conservatives vastly prefer tax cuts of any variety to (loathed) spending increases when it comes to activist fiscal policy. (Tax cuts are, however, less efficient in spurring demand than direct spending as some of a tax cut will be saved—the amount of which depends on the marginal propensity to consume of the households targeted by a tax cut.) That said, the payroll tax cut no longer looks palatable to either side of the aisle: Treasury Secretary Tim Geithner has stated that the administration will not push for continuation and House Republicans were badly burned in the last fight over extension of the payroll tax cut. So what should policymakers do if expiration of the payroll tax cut would exert a sizable economic drag, shaving 0.9 percentage points from real GDP growth and lowering employment by more than 1 million jobs, and this headwind cannot be replaced with more efficient direct spending?
In the summer of 2011, I published a paper arguing that replacing the payroll tax cut with a targeted rebate would produce a bigger and better economic boost. The numbers are a bit outdated (due to timing shifts, revised economic forecasts, and slight changes in estimated multipliers) but the three basic points are unchanged:
- The payroll tax cut is more targeted than marginal income tax rate reductions (truly lousy stimulus) but is not optimally targeted—it lacks a phase-out, resulting in a payroll tax cut of $2,200 for upper-income households (e.g., individuals earning $1 million annually) who are likely to save much or all of an extra dollar of disposable income. A tax rebate that phased-out tax cuts for households with low marginal propensities to consume would be more stimulative per dollar.
- The payroll tax cut has a relatively low phase-in rate (2 percent) and consequently actually raised taxes on individuals earning less than $20,000 ($40,000 for joint filers) relative to the Making Work Pay (MWP) tax credit that it replaced, which had a 6.2 percent phase-in rate. A targeted tax rebate could do even more to raise disposable income for lower-income households and alleviate poverty, particularly for families with children, than an extension of the payroll tax cut or the (smaller) MWP credit.
- The payroll tax cut sets a bad precedent for the future of Social Security, whereas a temporary tax credit from the general fund would leave intact dedicated funding for Social Security.
The targeted tax rebate we proposed actually was modeled off of the Emergency Stimulus Act rebate enacted in Feb. 2008 by George W. Bush—prompted, by the way, out of concern that the unemployment rate had climbed to 5.0 percent in Dec. 2007, up from 4.4 percent in May 2007. With headline unemployment at 8.1 percent four-and-a-half years later, there is an even stronger case for expansionary fiscal policy—the single most effective lever for boosting employment—rather than adhering to the misguided austerity path Congress has embarked upon.
Though their professed concerns about the “fiscal cliff,” policymakers on both sides of the aisle have finally acknowledged (tacitly or explicitly) that budget deficits closing too quickly—i.e., public debt rising too slowly—could cause a double-dip recession, and therefore the pace of deficit reduction must be slowed to accommodate job growth. If policymakers are serious about deftly maneuvering the fiscal obstacle course and boosting employment, replacing the payroll tax cut with a targeted tax rebate remains a second best policy option if more cost effective infrastructure spending or aid to state governments is effectively ruled off the table.