Deutsche Bank Explains Why The Payroll Tax Holiday Is A Game Changer, And Could Push GDP To 4.1%

First Check

Photo: Flickr via bigburpsx3

As we noted earlier, it’s almost depressing that the payroll tax holiday didn’t come sooner in the recovery.If this maths from Deutsche Bank is to be believed — and it seems pretty plausible — then the cut could be a game changer and add meaningfully to GDP.

According to our calculations, the Social Security tax reduction could add 0.7% to output next year, thereby taking Q4 over Q4 real GDP up to 4.1% versus our current 3.3% projection. This conclusion is based on the assumption that there are not offsetting expenditure reductions elsewhere in the Federal budget.

Wages and salaries currently total $6.44 trillion, and they have been growing by nearly 5% over the past couple of quarters. At that rate, wages and salaries will total about $6.75 trillion at the end of next year. Presently, individuals and their firms each contribute 6.2% up to a cap of $106,800 for Social Security. Under the payroll tax holiday, the individual’s contribution will temporarily fall to 4.2%. Based on the Social Security taxes paid in fiscal year 2009, we estimate that roughly 85% of total wages and salaries are subject to the payroll tax. This means a 2% reduction on payrolls taxes equates to a $115 billion increase in wage and salary income (i.e., 85% of $6.75 trillion is subject to the payroll tax, and a 2% increase in the product equals $115 billion). With the personal savings rate currently at 5.8%, we estimate that $108 billion of the “income gain” resulting from the payroll tax holiday will be spent. This is worth 0.7% of 2011 GDP. Consequently, the payroll tax holiday could give the economy an added fillip next year in addition to any incremental benefit from improving financial conditions, the full extension of the Bush-era tax cuts and the expanded business investment tax credit.

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