Will Cutting the Payroll Tax Increase Jobs? (Empirical Evidence from the EU VAT)

Abstract

Red Ink Rising, the Peterson–Pew Commission on Budget Reform’s report presents the country with a fiscal/employment dilemma – Congress must act immediately to stem the federal debt, but it must move carefully lest it harm employment in the fragile economy. In short, we must act fast and slow – we must decrease the debt and increase employment. This is a difficult task. The Peterson-Pew dilemma (notably its jobs-creation aspect) was taken to heart by both of the reform commissions that issued reports soon thereafter (National Commission on Fiscal Responsibility and Reform, The Moment of Truth and The Debt Reduction Task Force (Domenici/Rivlin), Restoring America’s Future). The dilemma also appears to be have played a role in President Obama’s compromise with the Republican leadership in the Tax Relief, Unemployment Insurance Reauthorization, and Jobs Creation Act of 2010 (P.L. 111-312) – particularly the 2% payroll tax cut enacted at section 601. The Congressional Budget Office (CBO) places the payroll tax at the intersection of the policies that Peterson-Pew examines. Empirical evidence from the EU suggests that P.L. 111-312 got it right (as between general reductions in the employees’ and employers’ payroll taxes). The evidence gathered in a two-year policy experiment conducted in nine EU Member States also suggests that the CBO estimates of employment gains from employers’ payroll tax cuts cannot be supported (if they are targeted generally). In addition, EU macro-economic simulations based on these findings also suggest that the best way to use payroll tax incentives to increase employment is to use them to directly reduce the cost of labor. This can be accomplished either (1) under mechanisms used in the HIRE Act or (2) by targeting specific categories of workers (the unemployed) for an employees’ payroll tax cut that would be tethered to (used in conjunction with) an employers’ tax incentive to significantly reduce the cost of labor. This paper endeavors to bring EU analysis into the US payroll tax debate. Five options are considered: •(1) Employers’ payroll tax holiday. •(2) Employees’ payroll tax holiday. •(3) Targeted employers’ payroll tax holiday. •(4) Targeted employees’ payroll tax holiday. •(5) Tethering an employers’ payroll tax holiday to a targeted employees’ payroll tax holiday.