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Will Obama Slash Payroll Taxes?

Barack Obama
CNBC.com
Barack Obama

I suspect that Obama's big jobs proposal later this week will be a deep cut in payroll taxes for employees and employers.

Last December, Obama signed a law reducing employees contribution to the payroll tax from 6.2 percent to 4.2 percent for the 2011 calendar year. The cut was meant as a stimulus but it does not seem to have been very effective. It was too small of a cut and its duration was too limited. Mostly, people just used the little bit of extra cash to increase savings and pay down debt.

But an immediate elimination of payroll taxes for employees and employers would likely have a major boost. It would add almost $1 trillion to the economy. Workers would have bigger paychecks and businesses would find it far less expensive to hire.

New York Times columnist Robert Frank explained the benefits of such a move back in June:

Larry Seidman, an economist at the University of Delaware, has estimated that if employee payroll tax payments were suspended from next month through 2012, the unemployment rate by the end of that period would be one percentage point lower than it would have been otherwise. Private-sector employment would thus expand by about 2.4 million workers by the end of next year.

Even greater employment growth would result from the employer exemption on new hires. Companies aren’t very likely to hire additional workers unless they can generate at least enough new income to cover their salaries, including all relevant taxes. The exemption would reduce the cost of hiring new workers by 6.2 percent—and even by conservative estimates, we can expect it to result in more than five million new hires.

I think, however, that one year is too short. People tend to spend according to their expectations of future income. That means that a tax cut of very short duration will not much increase aggregate demand. But if the tax cut were set to last for a few years—perhaps until 2013—then it might make a real difference.

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