The effects of the payroll tax holiday — part of the new federal tax bill being considered in Washington — depend on the flavor, if any, of Keynesian economics that best describes our economy.
Since 1983, employers and employees have each “contributed” 6.2 percent of payroll to the United States Treasury, earmarked for the Social Security program (those contributions apply only to the first $100,000 or so that each employee earns for the year). President Obama and members of Congress have proposed to reduce the employee contribution rate to 4.2 percent for the duration of 2011 while keeping the employer contribution rate at 6.2 percent.
They argue, and I agree, that the proposed tax cut will increase what employees take home after taxes.
Essentially all economists believe that it usually doesn’t matter whether employers or employees, or some combination, are obligated to pay Social Security tax, because the employer portion of the tax just results in lower wages for employees (and lower wages induce employers to hire more.)
Thus, if the current tax-cut proposal were instead aimed at employers, employees would still see more take home pay because employers could afford to pay higher wages.
From that perspective, it’s fine that politicians are proposing a cut for employees; maybe they score some extra political points for a cut that would be more obvious to employees than an employer cut would be.
However, one version of Keynesian economics stresses that our economic recovery from the recession is hampered by “sticky wages.” That is, employment would rebound more vigorously if only wages would fall, making it more economical for employers to hire. But imperfect competition in our labor market prevents wages from falling as much as would be efficient.
If the sticky-wage flavor of Keynesian economics were correct, then cutting taxes for employees has less impact on employment than cutting taxes for employers would, because the employer tax cut is the only way employers will see lower hiring costs. (It may be true that the employee cut would “put money in the hands” of different people than an employer cut would, and perhaps it is also true that money in the hands of employees would do more to increase national spending. But that effect on employment, if any, is less direct than lowering employer hiring costs).
I admire our labor market more than sticky-wage Keynesian economists do, but parts of the sticky-wage model are relevant for some sectors. In particular, minimum wage laws prevent wages from fully reflecting economic conditions, and those laws are most relevant for the low-skilled workers who are experiencing the highest unemployment rates.
If the sticky-wage Keynesians are right, then the employee payroll tax cut will have hardly any effect on employment among low-wage workers and will actually increase the measured unemployment rate for such groups, as they try harder to seek employment that, in 2011, would pay more after taxes.
Another flavor of Keynesian economics emphasizes sticky prices for consumer goods, rather than sticky wages. In this view, prices need to fall more to stimulate demand, and only that extra demand can create hiring. Unfortunately, they contend, imperfect competition in our consumer goods markets prevents prices from falling as much as would be efficient.
Sticky-price Keynesians agree that an employer tax cut would have the same effect as an employee tax cut. But both cuts have a minimal employment effect, if any, because it’s not employer costs that hold back hiring — it’s the lack of demand for consumer goods that would be there if only prices would fall.
Indeed, some sticky-price Keynesians have argued that payroll tax cuts would actually reduce national employment, because more people would compete for jobs that aren’t there.
In summary, the proposed payroll tax cut does not increase national employment in the sticky-price Keynesian model, regardless of whether the cut is aimed at employers or employees. The sticky-wage Keynesian model says that, because the cut is aimed at employees, it will not increase hiring in those sectors where wages are sticky — such as the market for low-skilled workers.
In my view, all flavors of Keynesian economics ignore the many mechanisms that permit markets to adjust to changes in costs and benefits. Although a minimum wage cut would be an effective and revenue-free way of raising employment, the proposed payroll tax cut increases the benefits and reduces the costs of employment and will result in more employment among people earning less than $100,000 a year — even among those earning the minimum wage.