How Is the Payroll Tax Cut Doing?

Copyright, The New York Times Company

The payroll tax cut is having the expected labor market effects, but those effects will reverse themselves when the cuts inevitably expire.

Beginning in January 2011, the payroll tax withheld from employee paychecks was temporarily reduced to 4.2 percentage points from 6.2 percentage points. The cut was scheduled to expire at the end of 2011, but Congress has continued it through the end of 2012.

My calculations last year, based on the proposed cut of 3.1 percentage points, suggested that the payroll tax cut “could raise employment by at least a million, albeit the duration of job creation is related to how long the tax cut lasts.”

On a seasonally adjusted basis, payroll employment was 130.2 million at the end of 2010, just before the payroll tax cuts took effect. As of last month, payroll employment was up 2 percent, or 2.5 million, to 132.7 million. The household employment survey tells a similar story. Aggregate hours worked — the product of employment and the length of an average employee’s work — increased almost 3 percent.

Of course, the payroll tax cut was not the only factor affecting the economy since 2010. If nothing else, population growth would have increased employment by about 1.2 million over that time frame. In addition to the increase expected from population growth, payroll employment therefore increased by another 1.3 million since the time that the payroll tax cut went into effect.

During the same period, various parts of the federal government’s 2009 stimulus package expired and state and local governments were, on average, laying off employees. Housing prices also fell somewhat — more than 4 percent according to the Case-Shiller index. One point of view is that government and housing contraction tends to reduce total employment, which makes it even more remarkable that the net result of the payroll tax cut and these contractionary events was an employment increase beyond population growth.

Regardless of the source of the two and a half million new jobs, employment is still millions below where it would have been if employment had grown with population since 2007. But nobody promised that a mere two-percentage-point payroll tax cut would bring the economy back all by itself.

This minirecovery may not last, because the payroll tax cut will eventually expire. When that happens, the payroll tax rate increase by itself will tend to reduce employment by about a million, so that employment can increase further only if population or other sources of economic growth are enough to offset tax-cut expiration.