In November of 2009, Stanford economist Michael Boskin, who served as CEA chair under President George H.W. Bush, published an influential Wall Street Journal op-ed that argued that a payroll tax cut would have proven cheaper and more effective than ARRA, the 2009 fiscal stimulus law:
There is little likelihood that another round of similar fiscal stimulus would yield much more than the paltry return on the first one. The original transfer payments and tax rebates barely nudged consumer spending, and the federal spending has been painfully slow. The delayed infrastructure spending—the shovels are still in the shed—will have a bigger impact, though less than claimed. Some of the funds to state and local government did reduce layoffs. The stimulus bill surely ranks dead last compared to the natural dynamics of the business cycle, the Fed’s zero interest rate policy, and the automatic stabilizers in the tax code (which have reduced taxes proportionally more than income) as far as explanations for the improvement in the economy.
But to evaluate the stimulus properly we should consider not just what we got for the $787 billion cost but the effects of alternative policies that might have been enacted.
My Stanford colleague Pete Klenow and Rochester economist Mark Bils estimated that cutting the payroll tax by six percentage points (of the 12.4% Social Security component) would, under standard assumptions, increase employment by three million to four million workers—an amount equal to all the job losses since the stimulus was passed.
The payroll tax cut would have reduced firms’ costs by roughly the same amount as from the entire decline in employment. It would have cost less than half as much as the stimulus bill, gotten far more income into paychecks quickly and, most importantly, greatly reduced incentives for firms to lay off workers. In fact, it would have created incentives to hire.
Yet one of Boskin’s central points in the piece was that permanent policies were far more important than temporary policies:
By far the best response to these headwinds is to curtail the huge current and contemplated future government control of the economy with a clear, predictable exit strategy—before the programs become permanently entrenched, develop powerful dependent constituencies, and greatly increase the risk of rising interest rates, inflation and taxation. Doing so would more rapidly improve the outlook for permanent private-sector employment, investment and growth than any conceivable second stimulus. It would also allocate capital and labor to their highest value in providing goods and services that people actually want and need, not what government bureaucrats want them to have.
The jobs agenda must begin with a Hippocratic oath: First do no harm to employment. That means jettisoning or at least delaying job-killing energy and health-care legislation with their mandates, taxes and costs that especially hammer small businesses.
Also wind down, as soon as possible, the emergency measures which healthy businesses, households and investors fear will become permanent competitive impediments. [Emphasis added]
With this in mind, I asked Professor Boskin for his thoughts on the expansion and extension of the payroll tax cut in the president’s proposed American Jobs Act:
In late 2008 and early 2009, I advocated a large payroll tax cut on employers and employees, especially given a large stimulus bill was going to be passed. At the time, massive layoffs loomed and I thought, if the President and Congress insisted on doing something temporary as opposed to more sensible permanent lower corporate and personal rates, a payroll tax cut had the best chance of cushioning the labor market some. Unfortunately, we got the stimulus bill instead.
The December 2010 payroll tax cut was small and on the employee side only (while the employer part is ultimately shifted to workers, in the short run a payroll tax cut would be cash flow to employers;a common directive from VC firms out here to their portfolio companies in 2009 was get cash flow positive immediately, we won’t be supplying funds for some time).
All that said, most hiring decisions are based on the expected contribution to revenues of the firm compared to the cost of hiring the worker. A temporary partial payroll tax cut will be a very tiny cost reduction compared to the cost the firm incurs in wages, training, benefits, etc., especially over the few years firms base decisions on. There are a few industries where turnover is so high it might make a difference, but in most firms in most industries, the impact is too small to be quantitatively important, especially when you add in the costs Obama has added.
So that’s a long winded way of saying I do not support it, but it is “not bad for Obama,” i.e., may do a tiny bit of good (at several hundred thousand dollars per job), but is a lot better than more social engineering and pork spending that does nothing and then sets up more constituents demanding the subsidies be continued. Much better would be permanent tax reform with lower rates on a broader base. Better still, combine that with rigorous medium term spending control. That would not only help long-term supply side incentives, but would remove some of the uncertainty about future taxes that is inhibiting the economy now.
My colleagues at Economics 21 take a dim view of the proposed payroll tax cut, while Edward Glaeser suggests that a payroll tax cut be balanced by raising the retirement age. The editors at Bloomberg View gave Glaeser’s column a headline that suggested a less ambiguous endorsement, but headlines are challenging to write.