Is the Payroll Tax Cut a Good Idea?

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One of the proposed provisions in the deal to extend the Bush tax cuts is a temporary 2 percentage-point reduction in the Social Security payroll tax, from 6.2 percent to 4.2 percent.

The idea is to put more money in the hands of working families by lowering their taxes. But there are two problems with the plan: the cuts won’t stimulate growth and they will exacerbate our entitlements problem.


Tax cuts that stimulate real economic growth operate at the margins–affecting an additional dollar of income, or an additional dollar of savings and investment–not the first dollar of income. Supply-side tax cuts encourage additional production by stimulating additional work, saving and investment.

A payroll tax cut is not a supply-side cut and won’t have much impact on economic growth. Rather, it embraces the Keynesian idea that the economy is stimulated by putting a few hundred dollars in people’s pockets so they can consume more. The political problem is that supply-side tax cuts necessarily benefit higher-income workers and businesses–something President Obama is loath to do.

An additional (and not small) problem is that the payroll tax funds the two major entitlement programs, Social Security and Medicare, that are on a path to bankrupt the country. Now, even less money will be going into these failing entitlement programs. But at least it’s only temporary, right?

As we’re witnessing with the Bush tax cuts, once you’ve cut a tax, it’s difficult to raise it again, especially in a presidential election year, which would set in place a policy that will only hasten our entitlements crisis.

If there has to be a payroll tax cut, it actually makes more economic sense to give it to the employer half of the payroll taxes than to the employee. That would at least mitigate some of the risks of hiring new employees that have been imposed by Obama administration policies.

If the president’s goal is to put a few more dollars in people’s pocket, the payroll tax cut will do that. But if the goal is to get the economy going again, after two long years of failed Keynesian stimulus, well, look to add yet another year of high unemployment and slow growth.
Today’s TaxByte was written by IPI Scholar Dr. Merrill Matthews.