EconoMonitor

Nouriel Roubini's Global EconoMonitor

What America Needs Is a Payroll Tax Cut

From the Washington Post:

Nearly three years since the onset of the financial crisis, the continued weakness of the labor and real estate markets, U.S. consumers’ unbalanced balance sheets and fading support from policy stimulus have transformed the risk of a double-dip recession from unlikely to about a 40 percent likelihood. The government responded creatively and massively to the near collapse of the U.S. financial system: The Troubled Assets Relief Program, stimulus spending and near-zero interest rates for nearly two years prevented a second Great Depression.

But the Federal Reserve has little ammunition left to boost growth or fend off a slump. And the federal deficit has reached such levels that additional spending of the kind that helped kindle the mini-recovery of early 2010 looks unwise.

In the midst of an election with crucial implications for its ability to govern, can the Obama administration reduce the likelihood of a “double dip”?

The administration knows that it needs to fashion a revenue-neutral fiscal stimulus that increases labor demand and consumption. Its proposal to make permanent a research and development tax credit that dates to the 1980s, and then to enact a temporary investment tax credit allowing firms to write down capital investments at 100 percent of cost, are welcome — but too modest a cure for what ails the economy.

A much better option is for the administration to reduce the payroll tax for two years. The reduced labor costs would lead employers to hire more; for employees, the increased take-home pay would boost much-needed economic consumption and advance the still-crucial process of deleveraging households (paying down credit card debt and other legacies of the easy-credit years).

Most policy approaches, including the Obama proposals, have tended to subsidize the demand for capital rather than the demand for labor. That has the problem backward. In the second quarter, capital spending reached an annual growth rate of 25 percent. The argument that increased demand for capital leads to greater demand for labor (i.e., if you buy more machines you need workers to run them) has not held up. Firms are investing in capital goods, equipment and offshore offices that allow them to produce the same amount of goods with less — and lower labor costs. To avoid a chronic increase in the unemployment rate, we need to subsidize the demand for labor — achieving job creation — rather than making it cheaper to buy capital, as investment and other tax credits would do.

President Obama could fully fund the reduction in payroll tax by allowing the Bush tax cuts for people making more than $250,000 a year to expire. Meanwhile, the Bush-era cuts affecting middle- and low-income earners — the vast majority of Americans — would remain in place for the time being.

After two years, when U.S. growth is more robust and the pace of private-sector hiring has picked up, we can afford to phase out the payroll tax cut while maintaining the income tax rates for the rich. It’s possible also that we could increase the tax burden on the middle class over time to reduce our budget deficit.

Proportion is critical in designing the payroll tax cuts. Small and medium-size enterprises have had it rough the past three years. They are scrambling for operating capital as banks hold reserves tightly, and they face higher borrowing costs than large corporations when they do find willing lenders. To maximize the incentives for private-sector hiring, there should be sharper reductions to the payroll taxes paid by employers than for those paid by employees. This will counter the argument that the higher income taxes funding these payroll tax cuts will hurt the wealthy and small businesses (many of which are run by those same high-income individuals) and their willingness to hire. Moreover, any cut in the payroll tax reduces the costs of operation and labor for all businesses. Other targeted policies that induce smaller banks to lend to small and medium-size businesses may be needed.

Low-income workers have historically shown a much higher propensity to consume when given extra money, so the payroll tax cut should be designed to provide a larger-percentage break to those on the low end of the income scale compared with the upper middle class.

Payroll tax cuts for the majority of low- and middle-income Americans could be just the beginning. The administration could propose even deeper cuts in payroll taxes if the president could get Congress to accede to a partial expiration of the other 2001 and 2003 tax cuts. At the end of this year, marginal cuts in capital gains, dividends and estate taxes are all up for renewal. A partial expiration of those special reductions — more likely to hit higher-income individuals — would not have to raise rates to the levels that preceded the Bush tax cuts; it could also incentivize those companies that have built up huge cash reserves (in effect, overinvesting in capital at the expense of hiring) to increase their demand for labor.

These temporary changes could not realistically be promoted as deficit-reduction measures. But they would hold the line against additional government debt while the nation awaits the recommendations of the president’s bipartisan panel on deficit reduction. Absent a new stimulus package — which appears highly unlikely at this point — these cuts direct billions in cash back into precisely those American households most likely to spend it and those businesses most likely to apply it to hiring. A tiny percentage of the highest-income Americans will pay more for the service the government rendered to their brokerage firms and investment banks in 2008. In exchange, a large tax break can be fashioned for employers and employees that jump-starts consumption, encourages hiring and thereby reduces the risk of a double dip without busting the budget.

Editor’s Note: A longer version of this piece was made available to RGE clients earlier in the week, The U.S. Should Ignite Job Creation with a Temporary Cut in Payroll Tax by Nouriel Roubini


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8 Responses to “What America Needs Is a Payroll Tax Cut”

11b40September 18th, 2010 at 9:02 am

Well, finally.The whole idea of trickle down, supply side econ has always seemed bogus to me, and our current situation seems to be evidence that my suspicions are well founded. Supply follows demand, not the other way around. The problem on Main Street is a severe lack of demand, coupled with being choked to death by big multi-national corporations that have had their lobbying armies writing laws for their benefit.Slashing the payroll taxes should have been done long ago – bailing out many of the “special interests” should have never happened. Special interests are by definition contrary to the general interests. Payroll tax reduction goes directly to the general interests and allows the citizen worker to vote with their pocketbook, bailing out the businesses they believe in with their hard earned dollars. This is very unpopular with the ruling classes of politicians and lobbying groups as power and control are taken away, but it is the right way to go about re-building our society.Independent Contractor

hloweSeptember 19th, 2010 at 7:36 pm

Speaking of finally,Roubini, Zandi: Mortgage defaults as economic therapy”Top economists Nouriel Roubini and Mark Zandi took the stage at an International Monetary Fund conference room on Friday and presented a novel spin on the mortgage defaults still plaguing the home industry: they may be “therapeutic.” Instead of letting the housing market continue to bleed out slowly for years to come, they should be accelerated so that home prices and household equity can start to recover, Roubini and Zandi said..”Sounds great! “Novel spin” seems to indicate a blind spot for Austrian economics by the author.”Roubini went further, proposing a massive, nationwide mortgage writedown instead of clogging bank offices and bankruptcy courts with case by case renegotiations.”Professor, why do you prefer bailing out people that are upside down vs. supporting contract law?Must we continue to bail out those who either made an error in purchasing beyond their means, or even those who took risks and lost? Many ordinary people (like me) recognized the housing bubble in 2004; many are still waiting for nature to take its course. How about showing some support for the other team?Many stand ready to buy if prices fall, many others sit in their nice home for months and sometimes more than a year while not making any payments. Can you please help us understand why you support bailing out the team that obviously has many unethical members? Are you trying to fix things that all ready have fixes built into the system?

hloweSeptember 19th, 2010 at 7:38 pm

Speaking of finally,From the WashingtonpostRoubini, Zandi: Mortgage defaults as economic therapy”Top economists Nouriel Roubini and Mark Zandi took the stage at an International Monetary Fund conference room on Friday and presented a novel spin on the mortgage defaults still plaguing the home industry: they may be “therapeutic.” Instead of letting the housing market continue to bleed out slowly for years to come, they should be accelerated so that home prices and household equity can start to recover, Roubini and Zandi said..”Sounds great! “Novel spin” seems to indicate a blind spot for Austrian economics by the author.”Roubini went further, proposing a massive, nationwide mortgage writedown instead of clogging bank offices and bankruptcy courts with case by case renegotiations.”Professor, why do you prefer bailing out people that are upside down vs. supporting contract law?Must we continue to bail out those who either made an error in purchasing beyond their means, or even those who took risks and lost? Many ordinary people (like me) recognized the housing bubble in 2004; many are still waiting for nature to take its course. How about showing some support for the other team?Many stand ready to buy if prices fall, many others sit in their nice home for months and sometimes more than a year while not making any payments. Can you please help us understand why you support bailing out the team that obviously has many unethical members? Are you trying to fix things that all ready have fixes built into the system?

Modern Money MechanicsSeptember 19th, 2010 at 8:24 pm

Jim Willie has given a few interviews on Max Keiser.Jim says gold is up because central banks are buying and they are buying because of systematic “raids” on LBMA and COMEX. Asian and Middle Eastern billionaires see LBMA tapping into their *allocated* accounts, so they engaging in coordinated “attacks” to extract their gold and safeguard it in their respective countries.Even though the FX markets are silent, this will have huge ripple effects in as little as a few months or maybe a few years.=======================================MAX KEISER INTERVIEW (Sept 17th, three parts with video)http://www.youtube.com/watch?v=IDuZmmz3dqghttp://www.youtube.com/watch?v=5OLyLifIktshttp://www.youtube.com/watch?v=MaWi5heq5mwMAX KEISER INTERVIEW (July 30th, two parts with video)http://www.youtube.com/watch?v=GZ2swdKWbHEhttp://www.youtube.com/watch?v=YUxZRJxNrMI

11b40September 19th, 2010 at 9:52 pm

Nature will take it’s couse. There is not enough money or support for massive RE bailouts. Stay tuned. The taxpayers are gradually awakening and the realization of what has happened with the previous bailouts is sinking in. Politicians from both parties on the campaign trail are finding angry voters fed up with legislation benefiting the few at the expense of many. Savers are realizing they have been badly penalized in order to help the profligate.Things are not getting better for most of Main Street, nor are there any rays of sunshine on the horizon. There is an extreme lack of demand that is getting worse, and very little reason to expect unemployment to improve. Where will the jobs come from? Governments have been suplying most of the new jobs for the past couple of years, and virtually all of the good paying ones with benefits. That trend is ending. In fact, it will actually start reversing as state and local governments face the harsh reality of shrinking tax reveues meeting unfunded pension liabilites, high wages granted to union workers, service & infrastructure demands, and benefit programs that can’t be sustained without massive tax increases.The housing market has not seen the bottom yet. It’s no where in sight. Meanwhile, credit scores are plunging and the pool of qualified buyers is shrinking as the pool of available housing expands. The cycle feeds on itself, and more owners find themselves unable to sell if they want or need to. It’s already a buyer’s market, a trend that will be with us for a long time to come.Next comes commercial RE. Already, 20% of the notes on hotels are past due. Office buildings and shopping centers are not faring much better, with revenues plunging as small businesses go under and big ones cut back.Spend a little time over at http://www.zerohedge.com for a real education backed up with facts, figures, charts, & graphs.How much longer the wizzards of Wall St & the FED can keep the ponzi stock market blown up is anyone’s guess, but one day in the not too distant future we will see another big plunge and even the high frequency trading quants may decide it’s too risky. If that happens, it will be a long drop to the bottom. Already, Wall St is set to eliminate about 18,000 jobs over the next year.2011 is going to be one hell of a year.Independent Contractor

ATSeptember 20th, 2010 at 4:00 pm

I enjoyed your article about reducing payroll taxes for two years to reduce the cost of labor. You state that the reduction can be paid for by letting the Bush tax cuts expire for those at the upper income brackets.I just want to point out, that these tax cuts are already going to expire on 1/1/2011. Therefore they are already counted in the next year’s fiscal budget.To pay for the payroll reduction, you must raise other taxes or increase the deficit.

TGSeptember 20th, 2010 at 4:04 pm

Mr. Roubini:In reference to your comment about the economy needing a payroll tax cut – I agree entirely! And what Obama doesn’t understand because he probably never paid social security tax, he could make it effective 10/1/10 and all of the people like me who have made over $106,800 already this year, would not cost the economy an additional penny for the next three months since the tax is no longer being taken out of my pay. The lower income people would realize the effect immediately and would start to spend there extra money.

writer/researcherSeptember 22nd, 2010 at 11:21 am

My daughter and husband own a small business grossing between 2-3M annually…business in good operation for more than 25 years…always on cash basis….I queried them twice in the last two years on the question of increased hiring if “payroll” taxes were reduced….and just this morning again and the response is the same…Negative increase in hiring regarding the payroll taxes…the business of hiring/not hiring for small business is almost irrelevant….either you need to hire or you don’t..based on DEMAND, not supply.I also agree with another commenter above about 2011 going to be a very bad year.