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Since When Is a Payroll Tax Holiday Fiscally Responsible? Since Alice Said So.

November 23rd, 2010 . by economistmom

I have to admit that when I first heard about the payroll tax holiday part of the Rivlin-Domenici (Bipartisan Policy Center) deficit reduction package, I gasped with disbelief and said “what?!” Nearly $700 billion in deficit-financed tax cuts in one year is part of a plan to get back to fiscal sustainability?

But then I saw the other tax policy components of the BPC plan, including the thorough and progressive pruning of tax expenditures and the add-on consumption-based tax, and I realized:  this is certainly not a plan that shies away from the need to raise more revenue.

Here are a few reasons why I think the payroll tax holiday actually adds to the level of “fiscal responsibility” encouraged by the overall BPC plan:

  1. A payroll tax holiday is one of the most effective types of tax cuts (and fiscal policy in general) in providing short-term fiscal stimulus (increasing demand for goods and services, creating or saving jobs); the Congressional Budget Office estimates it has a high economic “bang per buck” because it follows the “three Ts” well: it’s timely, (well) targeted, and temporary.
  2. We know we’re going to continue to do lots of deficit spending over the next year or two.  When the economy is in no shape to call for deficit reduction, we can still promote “fiscally-responsible” policies by making sure we get the most benefit for the amount of deficit spending that we do.  That means we should be substituting high bang-per-buck policies for low bang-per-buck ones wherever we can–rather than just throwing more bucks at any old deficit-financed policies.
  3. The full (employer and employee) payroll tax holiday wouldn’t just have high bang per buck; it spends really big bucks, so it would presumably have a really “big bang.”  It would make any proposed extension of the Bush tax cuts in the name of stimulus look downright wimpy. Perhaps it would take away that excuse from the policymakers (including President Obama) for their obsession over the Bush/Obama tax cuts.
  4. But meanwhile, the longer-term cost of extension of the Bush tax cuts is far larger than the one-year cost of the payroll tax holiday, and we all know how hard it is for politicians to let go of the Bush tax cuts, so extension of the Bush tax cuts (for any reason and over any period of time) looks fiscally irresponsible relative to the one-year payroll tax holiday.
  5. In other words, my fantasy is that this flashy and fresh payroll tax holiday proposal might steal the show and bump the (temporary or permanent) extension of the Bush tax cuts off of the legislative stage. (Yes, I know this would have to happen very soon.)  Taking the Bush tax cuts out (for good) would be a very fiscally responsible outcome.
  6. Finally, having this large, deficit-financed proposal within the BPC’s overall deficit reduction package is a strong preemptive strike against critics who like to automatically dismiss fiscal consolidation proposals as out of touch with the reality of the currently fragile economy.

Bruce Bartlett is not so fond of this payroll tax holiday idea, because he doesn’t believe it would really be just temporary:

I just want to ask one question: What are the odds that Republicans will ever allow this one-year tax holiday to expire? They wrote the Bush tax cuts with explicit expiration dates and then when it came time for the law they wrote to take effect exactly as they wrote it, they said any failure to extend them permanently would constitute the biggest tax increase in history. Sadly, Obama allowed himself to fall into the Republican trap, but that’s another story. My point is that if allowing the Bush tax cuts to expire is the biggest tax increase in history, one that Republicans claim would decimate a still-fragile economy, then surely expiration of a payroll tax holiday would also constitute a massive tax increase on the working people of America. And what are the odds that the economy won’t still be fragile a year from now? Zero, I would say.

But I am generally a more cheery person than Bruce, so I have two simple reasons why I’m more optimistic about the payroll tax holiday being a truly temporary policy:  (1) it’s so much more obviously a temporary proposal, because it’s labeled a “holiday” after all, and it’s too big to be imagined in any more than a one-year chunk; and (2) if such a “big bang” of this highly-stimulative tax cut were put in place, we really wouldn’t need any more stimulus beyond the first year.

Who would have thought I’d find a large deficit-financed tax cut to be one of the most intriguing and promising ways to promote fiscal responsibility?

(Alice Rivlin, you are one clever woman!)

27 Responses to “Since When Is a Payroll Tax Holiday Fiscally Responsible? Since Alice Said So.”

  1. comment number 1 by: Monica

    This isn’t really on the topic of a payroll tax holiday (sorry!), but I just saw this http://www.washingtonpost.com/wp-dyn/content/article/2010/11/23/AR2010112306577.html and I find it so depressing. So how do we fix this one, EconomistMom? Or do we need PoliticianMom? (<– not Sarah Palin!)

  2. comment number 2 by: Gipper

    Rivlin Plan is DOA. 23% of GDP going to federal government spending! Why in God’s name would the Republicans ever sign up for that nonsense?

    I guess if you had Paul Ryan’s plan on one side and the Rivlin plan on the other side and worked to negotiate a compromise, then perhaps it makes sense.

    Outside of that, it is a farce. Pete Domenici is a tattered bi-partisan fig leaf for this monstrosity.

    Again, the Democrats have proven that they are not serious about significant entitlement program cuts. They assume they are a fixture in the political firmament and wait for Republicans to knuckle under and raise taxes.

    Oh well, there’s always the debt ceiling vote to clarify the vulnerability of the Democrats when it comes to paying for the welfare state. When that comes, then we’ll see some real bargaining going on.

  3. comment number 3 by: Bruce Bartlett

    Diane, if you really think a payroll tax holiday is the best way to stimulate the economy, fine. But I suspect that you don’t really believe that. I’m sure you could easily think up a number of fiscal measures that would be more stimulative and perhaps even less costly in terms of the deficit. But those would all involve spending and you know that Republicans will not allow it. So you have implicitly accepted the Republican premise that tax cuts–and only tax cuts–are permissable to stimulate the economy.

  4. comment number 4 by: economistmom

    Bruce: You’re right that there are many better ways to stimulate the economy, but none of those other ways have a prayer of knocking out the Bush/Obama tax cuts. (I recognize this is a long-shot, too, but at least it’s got a non-zero probability in my mind.)

  5. comment number 5 by: Bruce Bartlett

    I’d agree with you except for my fear that this one-year holiday will become permanent. That’s worse than doing nothing.

  6. comment number 6 by: Jim Glass

    CBO scores “reducing employers’ payroll taxes” as the second most effective stimulus option (after “increasing aid for the unemployed”) for increasing employment, per dollar of budgetary cost — e.g., having a much faster and somewhat larger total effect than “investing in infrastructure”. Table 1 (.pdf).

  7. comment number 7 by: Jim Glass

    Ooops, here’s the link:
    http://cbo.gov/ftpdocs/108xx/doc10803/01-14-Employment.pdf

  8. comment number 8 by: Gipper

    If the Republicans are smart, they’d adopt the Simpson-Bowles plan’s tax recommendations for revenue enhancement and then take the axe to Obamacare and whatever else they have the guts to be specific about. Here’s why:

    1. Lowering tax rates while eliminating deductions makes it plausible that Republicans aren’t violating their no-tax-increase pledge. Republicans could even make a Laffer Curve argument for why revenues go up to 21% of GDP, as estimated by CBO scoring. And 21% of GDP, while not 18%, is still a lot better than the 23% in Rivlin’s plan or what Paul Krugman or Economistmom would want.

    2. Simpson-Bowles were handpicked by Obama so he could hardly disavow their recommendations.

    3. If Republicans intend to use the debt limit vote as a negotiating lever, they have to have public credibility that they care about the reducing the deficit. They cannot use the debt limit vote to restore the Bush Tax Schedules and increase the deficit. Obama could shut down the government and the Republicans would lose that argument. Adopting Simpson-Bowles would put the onus back upon Obama, because the Republicans could claim they are adopting HIS commission’s recommendations.

    Now suppose that in addition to agreeing to Simpson-Bowles, Republicans also demand the repeal of Obamacare as a condition for raising the debt limit. Then Obama was lose if he tried to shut down the government because Republicans could argue that the revenue spent on Obamacare coud be devoted to lowering the deficit instead of creating a new entitlement.

    Obama would look selfish if he tried to shut down the government over repeal of his signature program.

    I think there’s a 30% chance that Boehner could actually lead the House Republicans to adopt this strategy. If he convinces Republicans cutting spending is the only way in the long run to keep tax rates low, then the Republican Party could actually be credible leaders for politically feasible fiscal reform.

  9. comment number 9 by: Jim Glass

    I guess if you had Paul Ryan’s plan on one side and the Rivlin plan on the other side and worked to negotiate a compromise, then perhaps it makes sense. Outside of that, it is a farce.

    None of these plans have any chance at all of being enacted, so don’t worry about it. But they all have the real virtue of being actual plans, no matter how bad they are.

    Ryan started a good thing. With luck we’ll get to a point where no critic of any proposed reform will have any credibility without coming up with budget-closing plan of one’s own — “What’s your idea that’s *better*?”

    Dean Baker won’t be able to say we can simply afford everything in entlitlements without telling how he’d pay for them … Paul Krugman will have to say the tax increases he wants equal *11 points of GDP*, as he told the Asia Times but for some reason has never said in the US … the Tea Partiers and Repubs will have to say how they plan to cut taxes yet also pay for Medicare and Social Security, etc.

    It will be a great thing when the “free lunch” of being able to criticize others’ solutions without putting up one of one’s own is available no more. All these plans are a step in that direction, no matter how bad, and should be encouraged on that grounds.

    Once we reach the point where the public realizes there is a problem to be solved and these pundits and politicians are required to put up coherent plans to solve it, with no more free lunches served to simple naysayers, we can hash out the plans by their goods and ills.

  10. comment number 10 by: Gipper

    Jim,

    Quite true. Plan versus Plan should be the new standard of political discussion. And it’s great to see a proliferation of plans out on the table. Glad you’re seeing the silver linings.

  11. comment number 11 by: Arne

    “Republicans could even make a Laffer Curve argument”

    So you condone lying.

  12. comment number 12 by: Arne

    “Paul Krugman will have to say the tax increases he wants equal *11 points of GDP*”

    That what it would have taken 5 years ago to cover Bush’s spending and to be running a real surplus.

  13. comment number 13 by: Arne

    “Dean Baker won’t be able to say we can simply afford everything in entlitlements without telling how he’d pay for them”

    Dean Baker has explained how he would cut health care costs. It can’t happen witha a Republican controlled House, but the numbers do add up.

  14. comment number 14 by: Gipper

    Arne,

    Rates go down, and revenues go up. Where is the lie? Do you condone stupidity?

    The notion of a Laffer curve with tax revenues on a y axis and a “tax rate” on the x axis describing a real tax system laden with exemptions, deductions, state level taxes, etc. is (pardon the pun) laughable. If people want to use the Laffer curve as an explanatory tool, that doesn’t make them liars anymore than Krugman is a liar for using Keynesian economic modelling to explain the economy.

    As for cutting medical costs, how is that working out in Massachussets? Not that empirical evidence would get in the way of ideological zeolatory of the unreality-based healthcare reformists. Just because the CBO says so doesn’t make it real.

  15. comment number 15 by: Arne

    When you adjust for inflation and population growth, rates go down leads to revenue goes down. Saying the opposite is a lie.

    Do private industry salaries somehow allow for more demand than government salaries?

    Massachussetts is not doing what Dean Baker says should happen. Have you actually read him?

  16. comment number 16 by: Gipper

    Arne,

    From the Washington Post 11-26:

    “Want an appointment with kidney specialist Adam Weinstein of Easton, Md.? If you’re a senior covered by Medicare, the wait is eight weeks.

    “How about a checkup from geriatric specialist Michael Trahos? Expect to see him every six months: The Alexandria-based doctor has been limiting most of his Medicare patients to twice yearly rather than the quarterly checkups he considers ideal for the elderly. Still, at least he’ll see you. Top-ranked primary care doctor Linda Yau is one of three physicians with the District’s Foxhall Internists group who recently announced they will no longer be accepting Medicare patients.

    “It’s not easy. But you realize you either do this or you don’t stay in business,” she said.

    “Doctors across the country describe similar decisions, complaining that they’ve been forced to shift away from Medicare toward higher-paying, privately insured or self-paying patients in response to years of penny-pinching by Congress. ”

    Oh yeah, just love those cost controls on our medical system. Working out just fine. No doubt Obama’s plan is going to work much, much better. Oh I’m sure Dean Baker has figured out the answers to the perenial problems of rationing that have eluded Socialists for over a century. Get a grip, Arne!

    I thought Simpson-Bowles raised revenue to 21% of GDP? Doesn’t GDP account for inflation and population growth?

  17. comment number 17 by: Arne

    “Doesn’t GDP account for inflation and population growth?”

    No, because productivity is increasing. Even so, take it that way if you wish. Income tax revenue dropped from 13% in 1981 to 11.5% in 1983. The Reagan tax cuts reduced revenue.

    Whether Baker’s ideas are workable with US politics the way they are IS questionable, but they certainly address the issue of an inadequate supply of doctors.

  18. comment number 18 by: Jim Glass

    “Paul Krugman will have to say the tax increases he wants equal *11 points of GDP*”

    That what it would have taken 5 years ago to cover Bush’s spending and to be running a real surplus.

    A real surplus of 7.5 points of GDP, no less. Which raises some questions like: What happened to the Keynesian notion of fiscal drag (the opposite of “deficits stimulate”)? … How would so much be “saved” without Congress going on a spending rampage with all that revenue? (Think of all that would have been thrown into Obamacare.) … Would it have been “Security Trust Fund II”? (Which is exactly what they are doing with the new Medicare taxes to be spent on Obamacare but somehow also credited to the Medicare trust fund.)

    Not that PK was wrong. We need a surplus along those lines to keep up with the accruing liabilities just for Medicare, Social Security and federal/military pensions, which the Treasury puts at about $2.5 trillion annually, in addition to the “normal” deficit that everyone talks about.

    But since he was right, why has he never said this here in his own column? Why is he now happy to run projected deficits long after the recession ends, saying the result will be no worse than the 1950s (when liability accruals were, you know, *not* running an additional $2.5 trillion a year)? Inquiring minds want to know. :-)

  19. comment number 19 by: Jim Glass

    “Dean Baker won’t be able to say we can simply afford everything in entlitlements without telling how he’d pay for them”

    Dean Baker has explained how he would cut health care costs. It can’t happen witha a Republican controlled House, but the numbers do add up.

    I won’t critcize DB’s plan for Medicare as far as it goes, no matter how bad it might be, ’cause I said I wouldn’t. But it doesn’t go anywhere near closing the budget gap as needed to avert the fiscal crisis circa 2030 — and so is not a budget plan at all. As per his recent “No Compromise on SS and Medicare” article, it’s an exercise in problem denial claiming “there really is no deficit problem” (how plain can denial be?) because the real problem is rising costs of health care (as if that doesn’t create a deficit problem).

    But that is bogus rhetoric. As Andrew Biggs points out, the crunch of 2030 is being driven not by rising health care costs but dominated by the rising number of retirees: Social Security, federal/military retirees (now accruing $500 billion per year that will be being paid off then) and the exploding numbers of Medicare recipeints, not the rising cost of recipients’ care.

    (The rising cost of recipients’s care only becomes the major factor sometime after 2030, rising from then to 2085 or whatever. But as there is no chance at all that these programs will come through the 2030 crisis unchanged in major ways — one way or another — projections after then to 2085 are pointless.)

    What’s Baker’s plan to cover all this? Let’s start with the small stuff, Social Security. Baker says that’s nothing.

    CBO and the SS Trustees say the annual cash flow cost of SS rises 1.9% of GDP from 2007 to 2030, via the loss of the surplus contributing to general revenue plus the operating cost of the trust fund. As nothing goes, compare 1.9% of GDP to the largest tax increases in US history. What’s Baker’s plan to cover that? That’s just the start of things he doesn’t cover.

    Whether Baker’s ideas are workable with US politics the way they are IS questionable, but they certainly address the issue of an inadequate supply of doctors.

    C’mon, how much is the “supply of doctors” as a percentage of the medical cost problem? Look at the pie chart.

  20. comment number 20 by: Arne

    “how much is the “supply of doctors” as a percentage of the medical cost problem?”

    Gipper was talking about rationing. That is a problem of supply.

  21. comment number 21 by: Arne

    “Why is he now happy to run projected deficits long after the recession ends”

    The end of the recession is the start of growth, not the point at which we have returned to pre-recession levels. I believe it is also fair to say that Bush’s decision to add to the debt rather than pay for the wars has altered Krugman’s viewpoint. What is the point in running a surplus when the other party is going to squander it?

  22. comment number 22 by: Gipper

    Arne,

    Well I guess you’re calling Simpson-Bowles liars. OK. You’re the expert.

    Jim Glass’ citation of the pie chart pretty well demolished your theory that letting in foreign trained doctors is going to significantly change Medicare. Especially since we know that in the UK with the kind of universal healthcare Dean Baker admires, the service problems are even worse!

    What’s the point of paying down a deficit when the Democrats will make it bigger? Obama’s first concern wasn’t paying down the deficit; it was to enact Obamacare — another entitlement program!!! He took enacted trillions in new taxes dollars that could have gone to future deficit reduction and decided the federal government needed to spend MORE!

    The real fight is not about the deficit. It’s about spending. Taxes (through inflation or the IRS) will follow wherever spending goes.

  23. comment number 23 by: Arne

    “Well I guess you’re calling Simpson-Bowles liars.”

    No, because although they increase revenue (or reduce tax expenditures if you prefer) by closing ‘loopholes’, they do not claim to raise revenue by reducing tax rates.

    Stop mixing your topics. Allowing competition by foreign doctor is something that Baker mentions that will deal with your rationing concern. As the author of the pie chart, Aaron Carroll, points out there are many reasons why US health care costs so much more (per person). Some of them are politically problematic, but to pretend Baker’s plan does not close the fiscal gap is just wrong.

  24. comment number 24 by: Arne

    “What’s the point of paying down a deficit when the Democrats will make it bigger? ”

    You have it backwards. Bush squandered the surplus that was handed to him by Democrats. ACA reduces the deficit and, more importantly, covers more people at a lower cost per person.

  25. comment number 25 by: Gipper

    Arne,

    Simpson-Bowles lowers tax rates, eliminates deductions and increases revenues as a percentage of GDP. Stop arguing with strawmen that I don’t support.

    Surplus was handed to Bush by a Republican Congress and an Internet Bubble generating enormous capital gains. Bush lowered tax rates because Republicans correctly feared that Democrats would simply agitate for higher spending instead of reducing deficit spending.

    Republicans care about deficits less than Democrats, no doubt. But that’s because Democrats want to expand government programs and Republicans want to decrease them. The battle is about the spending, not the deficit,

  26. comment number 26 by: Arne

    “Stop arguing with strawmen that I don’t support.”

    “Republicans correctly feared that Democrats would …”

    Interesting juxtapostion.

  27. comment number 27 by: Gstorm

    The payroll tax holiday idea has been out there for a while (http://moslereconomics.com/2009/01/21/proposal-update-for-obama/). The link takes you to Warren Mosler’s web-site, to his specific recommendations to Obama. He also advocates the federal government being the “employer of last resrt” to get to full employment, another “big ticket” item that would have a big bang for the buck. What do you think of that idea?