For more than a generation, the Republican party has stood for cutting tax rates and opposing increased tax rates. That commitment has, on balance, well served the causes of limited government, economic growth, and conservative political success. (We are not among those who imagine that we would somehow be a freer society if we still had 70 percent tax rates.)
In recent weeks, however, some Republicans have put themselves in the odd position of opposing a cut in tax rates that Democrats are proposing. They risk eroding the party’s traditional advantage on taxes, and for no good reason. Sen. Mitch McConnell, we are happy to note, said yesterday that more and more Republicans are coming around, and he expects the payroll-tax relief to be extended.
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In late 2010, the parties reached a deal to extend the Bush tax cuts for another two years. The deal also cut the payroll tax by two points for one year. Democrats want to extend that tax cut, but Republicans have resisted. They raise three objections.
The first is that temporary tax cuts are less beneficial to the economy than permanent ones, because they have a more limited effect on people’s incentives. This is true. But the income-tax reductions of the Bush administration came with an expiration date; their extension came with another; and Republicans have rightly sought to make them more effective by increasing their duration rather than by opposing them altogether. This objection offers no reason for refusing to do the same in the case of the payroll-tax reduction.
The second objection is that the payroll tax, unlike the income tax, funds Social Security and that reducing it therefore threatens that program. Republicans who make this argument have allowed themselves to be ensnared in the accounting fictions of the federal government. Almost any large tax cut — of income taxes or payroll taxes — reduces revenues and therefore reduces the government’s ability to spend money while staying solvent. The argument has also become weak even as a matter of accounting. For the foreseeable future, Social Security will cost the federal government more than the payroll taxes it collects, and income taxes and debt finance will have to cover the rest. The costs of Social Security are not a valid argument against payroll-tax cuts in particular.
The third objection is that the payroll-tax cut has been ineffective at creating jobs. Here again holdout Republicans have a double standard, demanding that this tax cut pass a rigorous empirical test that they never apply to other tax cuts. It stands to reason that the tax cut makes hiring more attractive to employers — only marginally more attractive, to be sure, but it is on the margin that we seek beneficial effects from improvements to tax policy. And there may be ways to make the tax cut more effective, such as applying it to the employer’s share of the payroll tax rather than the employee’s.
Republicans should by all means continue to oppose legislative packages such as the one proposed by Senate majority leader Harry Reid, which couples a temporary payroll-tax cut with a permanent increase in income taxes on high earners. But they should oppose them for the right reasons: because there are better ways for the federal government to balance the books, not because the payroll tax is sacrosanct.
The payroll tax reduces both wages and employment. When Democrats propose cutting it, the right response is: That’s a nice start.
This is one of the more ridiculous arguments I've heard in a long time. If you want to lower the payroll tax then reform social security. As soon as you divorce Social Security from the payroll tax, it becomes just another income transfer program that is going bankrupt the country. The longer you continue to do it, the harder it will be to stop. Find a better way to return the money to the people if that is what the Government wants to do and then cut a corresponding amount of real spending. NR shouldn't be supporting gimmicks that will bankrupt the country.
The payroll tax is paid by the employer. It should simply be added to the income tax rate to avoid confusing people. It is an income tax. Or the income tax is a payroll tax if you want.
Two points… First – The social security tax FICA is one of the few taxes that is earmarked for a specific purpose before it is ever collected. Although the tax is not enough to cover current expenses, it prevents the US Treasury from writing bigger IOU’s to the social security trust fund. Since social security is an entitlement that neither republicans nor democrats are willing to adjust, it stands to reason that a tax that keeps social security funded should not be tampered with. Extending the FICA tax cut for another year, we’re simply increasing the deficit – another republican no-no!
Second – The article states that “It stands to reason that the tax cut makes hiring more attractive to employers”. An employer would be more inclined to hire if the cost to the employer was lower. But the FICA tax cut only affects the worker’s share of the FICA tax. The employer still pays the full 6% share. There’s no advantage to the employer to hire.
I agree that taxes need to be cut. Cutting the FICA tax without dealing with social security reform is simply bringing social security closer to bankruptcy!
absolutely correct, dakotahawk. The reduction in FICA does not affect the cost of an employee to the employer. This cut is just more of the same "stimulus" that NR commentators continually decry!
I don't understand this at all. How does lowering the employee side of the payroll tax make it even marginally more attractive for employers to hire employees? I'd be more than happy to accept a tax cut on the employer side of the payroll tax but I don't see how there is any incentive in an employee cut?
All three of the points in this article are unconvincing. At the end of the day there are a limited number of tax cuts we can pass (absent complete overhaul of the IRC) so why shouldn't we push for ones that actually promote growth and help the economy, rather than anything with the label of tax cut on it?
The author(s) of this article appear to have forgotten that the payroll tax cut as currently implemented only applies to the employEE, not the employER. Therefore there is no hiring incentive.
I detect Ponnuru's fingerprints on this one. He made similar weak arguments in his "Freeloader Myth" article last week.
NR should know very well that it's marginal rate cuts that best affect incentives and behavior. A temporary payroll tax cut is about the worst way to cut taxes from the perspective of economic effects. Moreover, the current tax code is unjustly progressive. A payroll tax cut exacerbates that injustice.
"Moreover, the current tax code is unjustly progressive. A payroll tax cut exacerbates that injustice."
This statement is simply unbelieveable - even for NRO readers. The US Tax code is unjustly progressive? A tax code that taxes actual WORK at a higher rate than collecting a capital gains check is unjustly progressive? A tax code that taxes hedge fund managers at a lower rate than actual WORK is unjustly progressive? A tax code that stops SS taxes at $106K is unjustly progressive? As someone else said above, NRO loves tax cuts for the wealthy - tax cuts for working people not so much.
The naysayers are going to have to explain how letting the FIT rates for the *top two brackets* expire at the end of 2010 (33% => 36%, 35% => 39.6%) would have constituted an unacceptable tax hike, but stopping the FICA withholding for *everyone* go from 4.1% to 6.1% at the end of 2012 would not.
The Democrats have maneuvered us into a corner. It's time to admit it and live to fight another day.
The answer to your question is an easy one. Letting the marginal rates increase would have had a negative impact on economic growth and on tax revenues in the long run. It would have hit small business when they could have least afforded it. Payroll tax cuts on the employee side do not incentivize hiring (even marginally) and their elimination or expiration would not negatively impact economic growth and tax revenues.
Tax cuts are not an absolute good. They are good when they have a good impact. Ie. when they incentivize growth and help people get jobs or keep jobs. They are good when they make real people's lives better and don't have large negative consequences. Keeping marginal rates low is good becuase they have all kinds of good effects that help grow the economy and make people's lives better. Employee side payroll tax cuts do not create the same incentives and they hasten the bankruptcy of social security.
Indeed it is not complicated stuff. For example, it matters not whether the cut is on the employer or employee portion of the tax.
If the cut is at the employer end, the direct cost of employment goes down and the employer can (1) either pay more to the existing employees, if that is what is required to keep the employee or (2) hire more people.
If the cut is at the employee end, the employee's after-tax paycheck goes up. Hence, in effect, this is similar to (1) above. Now if the equilibrium price of labor DOES NOT change because of the tax cut, then the employer can pay less to the employee but the employee will see the same paycheck as before, so no change in incentives for the employee and the employer can hire more with the savings, as in (2) above.
The answer to your question is an easy one. Letting the marginal rates increase would have had a negative impact on economic growth and on tax revenues in the long run. It would have hit small business when they could have least afforded it. Payroll tax cuts on the employee side do not incentivize hiring (even marginally) and their elimination or expiration would not negatively impact economic growth and tax revenues.
Tax cuts are not an absolute good. They are good when they have a good impact. Ie. when they incentivize growth and help people get jobs or keep jobs. They are good when they make real people's lives better and don't have large negative consequences. Keeping marginal rates low is good becuase they have all kinds of good effects that help grow the economy and make people's lives better. Employee side payroll tax cuts do not create the same incentives and they hasten the bankruptcy of social security.
Howie, I think I get it. Tax cuts are not a universal good, but only when they're going to the rich. Your right, the Republican position on tax cuts is simplicity itself. Cordially, Bill
Thanks for the reply. However, you assume without proof that the 2% FICA cut has no effect on the economy, that it doesn't create growth and job creation. I believe the total of this cut is in the range of $124 billion/year. As a point of reference, we burn about 100 billion gallons of gas/year. The 2% FICA cut is therefore comparable to a cut in the price of gas of about $1.24/gallon.
Also, I am sorry but your reference to hastening the bankruptcy of Social Security is fatuous. There is no difference between the money the Social Security Administration pays out when a retiree deposits a benefits check and the money the U.S. Treasury pays out when a defense contractor deposits a payment on a weapons purchase. Same pocket: Uncle Sam. Same source: us.
180 there are two kinds of cuts potentially aimed at growth. Supply side and demand side. The payroll cuts as you accurately described could potentially act as a demand side stimulus. They could in fact get people to go out and by more goods. But I have two problems with that. 1) The cuts are temporary and that is not calculated to get people to spend more money. There is too much uncertianty in the future with both these cuts and the economy in general and therefore they are not likely to get people to spend more money. 2) This is well beyond the purview of a post on a board but I am not convince by the historical case for demand side cuts.
This is not the same as lowering the price of gas which is both a demand and supply side cut. (it lowers the price of producing and shipping goods.)
Be careful what you wish for. Expect that the democrats will continue to use this to further limit the tax burden on their voters and raise them on the "rich". The funds are earmarked to Social Security. The fact that they don't cover expenses, or are diverted doesn't change this.
Democrats will, in the near future, argue that we have to raise taxes on the rich to save SS. This ineffectual tax cut will worsen the financial standing of SS requiring much larger taxes to be paid by the "rich" as part of any entitlement "fix".
People need to pay for the government they demand. The very people who need SS are the one's who will be paying less to see that it is funded (or at least accounted for). We need more people paying at lower rates, not fewer people contributing to services they demand.
Bad economics and bad politics. Sorry, you guys are wrong on this one.
