Payroll Taxes: The Policy Fight

by Douglas Holtz-Eakin


Lost, perhaps, in the furor over the process of extending the payroll-tax holiday is what’s at stake from a policy perspective. To get a feel for it, let us run the numbers.

As a benchmark, consider the household-budgeting problems facing a 41-year-old head of household who makes $50,000 a year. Suppose she expects to see real incomes rise at 2 percent annually, pay an average overall effective tax rate of 15 percent, and retire at age 65, and anticipates a ten-year retirement with income that replaces half of her labor-market earnings.

Based on the above and running the numbers, the household head would spend $49,290 (inflation-adjusted) annually, borrowing up front, saving during the later part of her career, and living off the surpluses during retirement. What does a 2 percent payroll-tax holiday of $1,000 do for the worker? Adjusting the numbers, she would spend $49,335 — a massive “stimulus” of $45. The bulk of the holiday would be saved.

This is hardly a surprising result. By and large, the holiday is the moral equivalent of sending the worker a check. The U.S. sent checks in 2001 and again in 2008 — and was disappointed each time. (Fool me once, shame on you. Fool me twice, shame on me. Fool me three times?)

Now, suppose that instead our worker can only anticipate one-sixth of the holiday — two months. She spends $49,298. That is, the inability to lock in the full year knocks $37 dollars (82 percent) of the impact off the books.

There are, of course, a gazillion caveats to these benchmark calculations. Our worker faces great uncertainty over the future (and might spend less), she could have difficulty borrowing (and thus spend less overall but more of the holiday), she might be trying to save for a college education (spending less overall and of the holiday) — and the list goes on. But while these caveats will affect the overall spending levels, they will do little to change the relative impact of a two-month versus a one-year holiday.

These basic calculations remind us of two important lessons. First, continuing a weak-kneed policy from 2011 will not generate jobs in 2012. The United States needs fundamental reforms to taxes and entitlements to restore its promise as the greatest economy on the globe and to meet its moral obligation to the next generations.

Second, a two-month extension is a policy air-ball. Period. This dispute is about politics, pure and simple.

At present, the ball is in Harry Reid’s court. The moment the House voted, the bill was returned to the Senate, where it sits awaiting action. President Obama and chief political lieutenant Reid can talk until they are blue in the face. The fact is that John Boehner could not hold the vote on the two-month Senate-passed fiasco that they demand, even if he wanted to.

For political purposes, Harry Reid is holding the bill hostage. Shame on him. If he wants to transform bad policy to mediocre, he should get his keister back to the Senate, extend the payroll holiday for one year, and then go home. 

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