The Case for Subsidizing Wages with a Negative Payroll Tax
Paying employers and employees through the payroll-tax system is a faster, more efficient way to keep them together for the long haul.
NRPLUS MEMBER ARTICLE A s we’re already quickly learning, there are several implementation challenges in delivering seriously needed trillions of CARES Act relief in a timely manner to Americans amid the COVID-19 economic shutdown.
Despite the rapid scaling up of Paycheck Protection Program forgivable loans, SBA-approved banks and lenders will still take weeks to process them and distribute actual funds to businesses. Not to mention, the SBA has run out of its $350 billion in allocated funding, bringing Congress back to the negotiating table. Negotiations are currently at a standstill, causing further delay.
The U.S. Treasury has started distributing Economic Impact Payments, one-time checks from the IRS in the amount of $1,200 for individuals ($2,400 for couples and $500 per child). While a minority of Americans who have direct-deposit information on file with the IRS are already receiving funds, most Americans — including those who file their taxes through H&R Block or TurboTax, which don’t provide direct-deposit information to the IRS — still won’t receive their checks in the mail for weeks.
The Fed is still setting up its new credit facilities — including its Main Street Business Lending program, which will be able to lend up to $600 billion using loss guarantees from the CARES Act — to incentivize bank lending to ordinary businesses. However, several implementation challenges exist, including requiring banks to share 5 percent of the risk. The Dodd-Frank Act’s changes to the Fed’s emergency-lending powers require it to lend only to “solvent” institutions, creating further challenges and operational delay in attempting to test for pre-COVID-19 business solvency.
All of these components of the CARES Act have several implementation problems taking up meaningful amounts of precious time, all while employers continue to lay off millions of workers.
Expanded unemployment-insurance claims are being delivered faster, although some states have unemployment-claim-delivery infrastructure running on a half-century old, defunct computer language. The CARES Act expands unemployment insurance to deliver an extra $600 per week from the federal government on top of lost wages. But these new benefits are so generous they might encourage employers to fire their workers or cause workers to want to be fired or furloughed. That perverse incentive increases the likelihood that employees may choose not to return to their jobs post-crisis, which would, in turn, inhibit the ability of employers to get operations back up and running.
Why not deliver a faster and less administratively challenging stimulus through the payroll system that will incentivize employers to keep their workers on payroll and encourage workers not to leave?
That is exactly the idea behind introducing a negative payroll tax to subsidize wages on top of the payroll-tax waiver. By bringing the payroll tax below zero, we could create a direct wage subsidy, assuaging critics who have argued that a payroll-tax cut alone provides too little relief. The beauty of using the payroll-tax mechanism for this is that it bypasses the need to go through inefficient and expensive government and banking procedures.
The CARES Act does provide the Employee Retention Tax Credit, a payroll-tax credit equal to 50 percent of certain wages paid by eligible employers. The spirit of this provision is welcome, but it could go much farther. Along these lines, Senator Josh Hawley has now proposed a new plan with a payroll-tax rebate that covers 80 percent of payroll expenses and an employee-rehiring bonus. But we would go further than that.
A recurring payroll-tax cut and biweekly payroll subsidy, rather than a one-time tax credit, would be faster and likely help boost spending because of what behavioral economists call “mental accounting,” the notion that people are more likely to spend money that they see as a permanent boost to their income. According to Gallup polling, only 20 percent of Americans plan to devote one-time stimulus checks under the CARES Act to consumption, while the rest intend to save the money or use it to pay down bills.
If our proposed payroll measure were temporary, lasting until, say, the end of this year or the next, it would incentivize people and businesses to work a lot harder as the economy reopens to take advantage of the tax abatement before it disappears. The urgent need people will have to earn more income coming out of the pandemic crisis would be matched by an opportunity for greater short-term rewards.
Private payroll-processing firms such as ADP and Paychex could help deliver the subsidy provided by such a negative payroll tax quickly. And the Treasury Department has already set up some payroll-payments infrastructure to deliver the Coronavirus Response Act’s paid-family-leave advances that could be repurposed to implement a wage subsidy.
A payroll-tax waiver or wage subsidy would also allow employers to reduce their wage costs (overall and per employee) without reducing employees’ paychecks. The “sticky wages” phenomenon, in which employers can’t cut wages during a crisis because employees generally won’t accept such cuts, is one reason why economists believe massive spikes in unemployment occur during recessions. A payroll-tax waiver or subsidy would go some way to tackling this problem and act as something of a brake on rising unemployment.
Wage subsidies are not without costs, both static in the form of the money the government spends on them and dynamic in the form of the labor-market distortions they cause. For example, a wage subsidy such as today’s earned-income tax credit phases out as the recipient’s income rises, meaning that they will be disincentivized to earn extra dollars as the phaseout increases their marginal tax rate. In contrast to experiments with negative income taxes in the 1970s, which were shown to discourage work, using a negative payroll tax to (effectively) pay employers and employees to stay together could avoid such drawbacks so long as there was relatively little means testing and phaseouts were long and gently sloped.
We hope this idea is something that Congress will consider. The chances of a fast recovery will be increased if employers and employees who were together prior to the crisis are able to stick together. The less we smash up, the less there will be to repair.
— Arthur B. Laffer is the chairman of Laffer Associates and a member of President Trump’s economic-recovery task force. Jon Hartley is a master’s candidate in public policy at the Harvard Kennedy School of Government and previously was a senior policy advisor on the U.S. Congress’s Joint Economic Committee.