Monday, August 22, 2011

Unemployment and the Payroll Tax

Remember when President Obama and his team promised that if only we passed an emergency “stimulus” bill allowing them to wantonly spend $787 billion, unemployment would be capped at 8%? Two years later, having soared as high as 9.8%, July’s unemployment rate stands at a dismal 9.1% overall, and at a staggering 25% for those aged 16 to 19! Throw in so-called “discouraged” and “underemployed” workers, and these rates increase by half again.

Simultaneously, the costs of the government’s massive redistribution efforts have torpedoed our once pristine credit rating, shell-shocked private business owners, disillusioned the few employed taxpayers who still remain, and sent consumer confidence to a new 30 year low.

Mercifully, however, there is a silver lining. It appears that the utter failing of all of Obama’s programs and predictions has him tinkering with something new. Rather than reflexively using more government force to further redistribute wealth and impede commerce, he’s actually considering restoring a modicum of freedom to the labor markets. In various speeches around the country, the President now says he’ll propose an extension to the temporary 2% reduction in payroll taxes that was instituted for 2011.

Recall that payroll taxes are imposed on both employees and employers allegedly to pay for future Social Security and Medicare benefits. In reality, the funds aren’t segregated and are effectively spent as they’re collected. As a result, payroll taxes constitute another form by which the government redistributes wealth.

Moreover these taxes are by no means trivial. Prior to the temporary 2% reduction, most employees had to surrender 15.3% of their earnings directly to Washington. This is a significant percentage, particularly when expressed as a fraction of an employee’s discretionary income. Indeed, many lower income earners have no discretionary income at all in large part due to the payroll tax.

Obama’s proposal then is a tacit acknowledgement that payroll taxes represent a hefty punishment for working and a powerful disincentive to hire. And while these taxes are damaging to every potential worker — they’re perhaps most harmful to those who don’t yet have the experience or skills to justify higher wages, i.e. to the young. No wonder a quarter of our youths can’t find a job.

So, possibly for the first time ever, I find myself agreeing with the President. Reducing the payroll tax is a good idea. But if a temporary 2% reduction is good, wouldn’t a permanent end to the entire 15.3% tax be much better?

Consider that under the President’s proposal, wages are still taxed at 13.3%, and would jump back to 15.3% in a year. That’s not exactly conducive to hiring. Why not fully apply the logic behind the reduction? Eliminate the tax entirely, so that anyone who’s willing, can once again be productively employed. And make the cut permanent so that private business owners — the people who create real jobs — can do so in a stable and predictable environment (something which would be a welcome novelty from this administration).

Now of course for anyone who’s fiscally responsible (which likely leaves out the President), a cut in taxes must also entail a counterbalancing cut in spending. Consistent with an end to payroll taxes would be an end to the programs they’re earmarked for. That means phasing out the immoral, Ponzi-like schemes of impossible promises which are our entitlement programs. (Elsewhere I’ve suggested a starting point on how to go about this. The basic idea would be to return the dollar amounts that people have contributed to the programs, but to stop accruing any more money towards them.)

Ending entitlement programs means that instead of treating workers as helpless wards of the State, they’d be recognized as the adults they are; fully capable of planning for their own retirements and healthcare. Put more broadly, it means abandoning government paternalism by empowering those who earn the money to save, spend, and invest it according to their own personal needs, values and priorities.

Understood this way, eliminating payroll taxes — and the paternalistic programs they’re associated with — is a win-win proposition whose time has come.


Blogger Realist Theorist said...

While I'm all for winding up all entitlement programs, I think that cutting taxes without cutting the outflows is not a good idea. I'd like to see spending-cuts come first.

I don't believe cutting payroll tax rates will make a significant difference to hiring in our current environment. (Salaries are still quite "sticky".)

It might actually help if the government were to reduce the "employer's portion" of the payroll tax to zero and take the whole amount from the employee's paycheck. Most employers would adjust base-wages to make the employees whole: so, no change there. However, an across-the-board change like that, if accompanied by the right political message, might actually have an effect of reducing average wages for some current employees.

Even without any impact on lowering of wages, it is better for employees to see the whole tax amount on their paychecks.

6:20 PM  
Blogger Amit Ghate said...

Thanks for the comment.

Of course there’s no perfect way to get out of the mess we’re currently in, and I’m certainly not wedded to all the particulars of my proposal, but here are a few reasons why it currently seems best to me.

First, I think the worst kinds of taxes are those that are targeted at productive activity. Payroll taxes certainly qualify (as do income and corporate taxes). Thus I’d prefer to see the spending paid for by consumption taxes and then perhaps poll taxes or property taxes. But of course the key to the whole setup is to end the programs so that eventually the government is no longer involved and thus no taxes are necessary to finance it.

Next, the consequence of high payroll taxes is, as I argue, unemployment. In our current system, that means taxpayers of some form pay for unemployment insurance and perhaps food stamps, welfare, etc for each unemployed person. Thus the damage is double: we lose the potential production of all the people who are put out of work while those who remain are now burdened with their own payroll taxes plus those taxes that pay for the “social net”. It’s a vicious circle that should be ended by ending taxes targeted at production.

As to your point of making the taxes explicit, I agree. And I’d say that applies across the board, if gas taxes were paid separately people would fight them more, ditto for all the licenses and fees businesses pay, etc. But I wouldn’t hold my breath on that score.

5:18 PM  
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