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Why Hasn’t the Payroll Tax Holiday Worked?

2 min readBy: William McBride

Friday’s dismal jobs report reveals that in both May and June the economy produced fewer jobs than it has in any month since September of last year. The unemployment rate inched up from 9.1 percent to 9.2 percent. For more than two years now the unemployment rate has remained at or above 8.8 percent — a post-Depression record. Further, nearly half the unemployed have been so for 27 weeks or more, and there has been no significant dent in this proportion since it peaked in early 2010.

The news seems to have refocused the deficit reduction talks, encouraging Obama to repeat his call for an extension through 2012 of the payroll taxA payroll tax is a tax paid on the wages and salaries of employees to finance social insurance programs like Social Security, Medicare, and unemployment insurance. Payroll taxes are social insurance taxes that comprise 24.8 percent of combined federal, state, and local government revenue, the second largest source of that combined tax revenue. holiday that reduces employee payroll taxes from 6.2 percent to 4.2 percent (payroll taxes are on the first $106,800 of earnings). The measure has the support of many House and Senate Democrats.

While this is no doubt an effective way to get cash into the hands of consumers, there are two reasons to think it is not an effective way to sustainably increase employment:

1) Tax holidays generally are a bad idea, in that they mainly amount to a windfall for one group or another without effecting long term economic plans.

2) This particular windfall would be to those who are already employed, amounting to a 2 percent raise for those making $106,800 or less. It would provide very little incentive for job creators, i.e. businesses, to hire on a long term basis. Instead, most of the money would likely be used to shore up household balance sheets – certainly needed but not likely to lead to significant hiring. Increased household consumption would lead to some hiring, e.g. McDonald’s hiring 50,000 to accommodate increased demand, but these are not the sort of high-paying, long-term jobs indicative of a dynamic and growing economy.

The problem we have is too many people standing in line for a job. We do not need to increase the incentive to stand in line, rather we need to increase the incentive to create jobs and invest in new hires, for the long term. This is best accomplished by permanently lowering the taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. burden on businesses, not just a select few on a temporary basis. Specifically, the top corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax. rate should be lowered immediately, as should the top personal income tax rate, since many businesses file under the personal income tax code.

President Obama and lawmakers in Congress should keep their eyes on the prize – until we have a return to full employment, everyone’s spending priorities are jeopardized.