Does a payroll tax cut work?

  • 29 August 2019
  • NormanL

The president has floated the idea of cutting payroll taxes as a way to increase economic growth and ensure against a possible recession. While it's still in the idea phase -- and may not happen at all -- such a payroll tax cut has happened before. The question is: does it work? The Congressional Research Service looked into that question. The answer is...it depends. One big consideration is timing:

To be effective, short-term stimulus should affect the economy during a period of economic weakness. Recessions are historically short-lived (though recovery from a recession may take a longer period of time). Since recessions are typically short-lived, effective stimulus should also typically be short-lived. A reduction in payroll taxes could be implemented quickly and be designed to expire as the economy strengthens. If designed to increase the take-home pay of workers, the resulting increase in household income could occur quickly.

While some economic indicators signal a recession may be on the horizon, the economy remains in its longest period of economic expansion. With unemployment at its lowest levels since the 1960s, and strong consumer spending, a broad range of economists have questioned whether this is the right time to enact a payroll tax reduction. If the economy were to head into a recession, existing automatic stabilizers (such as UC benefits) and monetary stimulus can serve as "first lines of defense." Should a recession become severe or prolonged, a payroll tax cut might be reserved as a policy option to address ongoing economic stagnation. A challenge for the effectiveness of any fiscal stimulus is the lag between changes in economic conditions, and the policy's implementation.

There's much more -- including the long-term fiscal effects of such a tax cut -- at the link.

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