Monday, February 2, 2009

A Robust Fiscal Policy Proposal

I am toying with this idea:
  1. eliminate the employer portion of the Medicare tax, which is currently 1.45% of payroll.
  2. increase the employee portion of the Medicare tax, which is currently 1.45% of wages, to 2.694% of payroll of wages.

If you believe that wages fully adjust in response to taxes, then this change would have no effect on a worker's take home pay, employer costs, or government revenue because wages would just adjust up in response to the changing incidence of the payroll tax. So you would have no problem with my proposal. There is the added bonus that this policy would make people feel like government is "doing something" when in fact it isn't.

If you think that wages are currently too high (a traditional Keynesian view), then my proposal ought to: lower employer costs, and thereby raise employment and government revenue. The only question is whether the amounts above are enough to bring employment back -- but at least it would be a move in the right direction (or no change at all).


Karl Smith said...

I actually like the idea of employer payroll tax cuts for fiscal stimulus.

The problem with raising taxes on employees, however, is that if wages are slow to respond then you could generate increased debt deflation.

In this case more strain on employees in covering mortgage costs and consumer credit costs, which could multiply through the economy.

Now of course at the same time you will slow layoffs, so it is not clear what the net effect would be.

One interesting point I'd like to hear your take on - Adjustable Rate Mortgages.

Neoclassical theory would suggest that ARMs are preferable, in that they reduce the exposure of both parities to inflation risk. With respect to the borrower, when nominal wage growth accelerates in relation to real growth the mortgage rate will go up.

When nominal wage growth decelerates the mortgage will go down. Yet, conventional finance and the current crisis seem to indicate that ARMs actually increase the risk of default.

My gut says this is telling us something about why prices might be sticky.


Tino said...

The employer "part" is not subject to local and federal income tax, but the employee part is, right? In that case this would amount to a tax increase.

Other than that the proposal has the added advantage of making taxes more visible. Once the economy adjusts the slack will be gone and the incidence identical.