Saturday, June 25, 2011

Listen Up People, Cutting the Employer Portion of the Payroll Tax is Not Good Policy

Economics is More than Supply and Demand

Earlier The Dismal Political Economist has explained why cutting the payroll tax in general and cutting the employer portion in particular is not effective policy for stimulating job creation.  Yet, despite the wisdom of The Dismal Political Economist, some people just persist in putting forth the notion that

of all the possible forms a stimulus could take, a payroll tax relief — especially on the employer’s share — is probably the best. The rationale is that if the government makes it less expensive for businesses to hire workers, businesses will tend to hire more workers.

So while the above argument sounds like good basic economics, it is not.  The idea that if you lower the price of an item people will buy more of it applies to end goods, goods people consume.  For labor, which is an intermediate good, the demand is driven by the demand for final goods.  Businesses hire employees to produce goods and service that the business can sell.  It does not hire employees to produce goods and service for which there is no demand simply because the price of employees has temporarily declined.

On a cost effective basis, cutting the employer portion of the tax is not very high.  This is because cutting the employer portion affects all employees, including those already on the payroll, but affects employment only at the margin.  If a firm employs 98 workers and the employment tax is cut and the result is for the firm to hire an additional two workers, you have the firm getting a tax cut on 98% of the existing work force with a benefit for only 2% of the resultant workforce.  Mostly the tax cut is just a giveaway to the business.

The Dismal Political Economist does not expect the above argument to hold sway.  There is Murphy’s Law of Economic Policy:

If the Wrong Policy Can be Adopted, The Wrong Policy will be Adopted.

Reality trumps rationality.


  1. While your argument is clearly correct in most ways, I disagree about the par where you say that cutting the employment tax affects employment only at the margin.

    Essentially all employees are at risk of losing their jobs. So what effect there is, is spread over most of them.

    Given your law that wrong policies will be adopted, would it be better to propose an even wronger policy? How about, we eliminate the employment tax for employers, and shift it entirely to employees! After all, having a job is a privilege and not a right, so it makes sense the job-holders should pay for it....

  2. I understand your point, but am scared to propose an even wronger policy for fear that will be adopted instead.

  3. The DPE, please don't propose an even wronger policy. You know how the masses are.

  4. I think most economists were only recommending keeping the current payroll tax cuts that are due to expire at the end of the year. If payroll taxes increase then businesses might decide to shed jobs even though they are flush with cash. This is the situation that everyone seems to be afraid of - not just anemic job growth but net job losses.