The most important element of the “fiscal cliff” is the one politicians seem least interested in doing anything about: the expiration of a payroll tax holiday that’s given a nice lift to the economy at no cost to anyone. A sensible Congress would be coming together on extending and even expanding the payroll tax holiday, even while continuing to argue about the other unrelated elements of the cliff. Instead, the ongoing controversy over high-end Bush tax cuts is crowding the agenda and may end up blocking what should be a no-brainer policy initiative.
It’s helpful to start by recognizing that the whole idea of a fiscal cliff is somewhat confusing. At the end of calendar year 2012, various fiscal initiatives are set to expire or to begin. One element is a series of corporate tax subsidies that Congress almost invariably extends but doesn’t like to make permanent. Nonpermanence both masks the cost when the Congressional Budget Office does the scoring and ensures that there’ll be a new round of lobbying as firms need to come back and argue for extensions. The dreaded “budget sequester” that resolved the great debt-ceiling crisis of 2011 is scheduled to start in 2013: “automatic” spending cuts, half to the military and half to the civilian side of government, that are supposed to motivate Democrats and Republicans to agree to some alternative framework. The Bush tax cuts are a third major element of the cliff and the most controversial. Obama’s proposal is to extend most of the Bush tax cuts but rescind the rate cuts for the top 2 to 3 percent of the population. That would raise ample funds to stop the sequester. Republicans want to extend all the Bush tax cuts and replace the defense sequester with cuts in programs for poor people.
The last—but by no means least—element is the payroll tax holiday. In the 2009 stimulus bill, the Obama administration included a $400 “Making Work Pay” tax credit. Republicans didn’t want to extend that policy during the last lame-duck session, mostly because it was too closely identified with Obama, but they agreed to a similar idea: a payroll tax holiday that reduced workers’ share of Social Security taxes from 6.2 percent to 4.2 percent. The idea of the payroll tax holiday was to give a boost to the economy in a form that’s ideologically congenial to Republicans and doesn’t risk becoming a permanent expansion.
It was a good idea in the winter of 2010-2011, when unemployment was high and interest rates were low, and it’s still a good idea today, when unemployment is still high and interest rates are still low.
Low payroll taxes boost the economy in several ways. For starters, the holiday puts more money into the pockets of virtually all Americans. For many of us, that means slightly higher purchases of domestically produced goods and services than we’d otherwise be making. For households constrained by excessive borrowing in the bubble years, it means speedier repayment of debts and a faster return to normalcy. For employers considering expansion, it also means slightly higher real wages for workers at no higher cost to the employer. That means at the margin it makes more sense to hire. So you’ve got more demand, faster deleveraging, and more hiring capacity. What’s not to like?
Josh Bivens and Andrew Fieldhouse of the Economic Policy Institute estimate that the employment impact of rescinding the payroll tax holiday will be larger than the impact of letting all the Bush tax cuts expire. Jan Hatzius, chief economist at Goldman Sachs, says ending the holiday would shave 0.6 percentage points off 2013 GDP growth, effectively canceling out the benefits of QE3. And that’s no coincidence. The Bush tax cuts are mainly about conservative long-term growth strategy (incentivizing the job creators) with a hefty dose of middle-class income boosting through tax credits and deductions thrown in to make the medicine more palatable. The payroll tax holiday, by contrast, was actually designed to be an economic stimulus measure.
And that’s why nobody’s talking about. The term “stimulus” became a dirty word long ago. Now with the election in the bag, the White House seems to care more about the odds of bolstering Obama’s legacy with a grand bargain on the long-term fiscal picture than with addressing the short-term jobs crisis. But the fact remains that this is an economy in need of stimulus. The inflation-adjusted yield on 20-year Treasury bonds is below zero, meaning it’s cheaper to finance federal spending with debt than with taxes. The unemployment rate, meanwhile, is still sky-high at 7.9 percent. Under the circumstances we ought to be talking about cutting the payroll tax more deeply. The cost to American society of people spending extra months in unemployment, losing motivation and self-esteem rather than earning income and building skills, is very high, while the cost to the American taxpayer of borrowing money is extremely low. If this expiration were happening on its own, it seems overwhelmingly likely that intelligent people in both parties would see that clearly. But the coincidence that the holiday ends at the same time as the Bush tax cuts has left the issue languishing in obscurity. Unless that changes in the next couple of months, we’re going to wake up in the new year with a much weaker labor market to go along with our hangovers.