The President has proposed tax relief measures to prod the nascent recovery. Business would get a total of $300 billion in tax cuts. About $200 billion of that comes in the form of a 100% deduction for spending on capital investment undertaken during 2010 and 2011. This would be spread over 10 years, to boost corporate spending now, while postponing the full impact on the government’s budget. In addition, firms would get a tax credit estimated at $100 billion—again, over the next decade—for research and experimentation. Finally, the President proposed to add $50 billion in infrastructure spending. All of this is to boost spending now, helping to create jobs, while also increasing America’s capacity to produce in the future by adding to our capital stock.
Who could be against such measures? Indeed, this is the typical government response to a business cycle downturn—dating all the way back to the Kennedy administration. All we need to do is to increase the business incentive to invest, thereby killing two birds with one stone—the short-term problem of job loss and the longer-term problem of a shortage of capital. Tax relief for business will create jobs and make America more competitive in the global market place.
If this were a garden-variety downturn, and if recovery really were underway, the President’s proposal might actually work. But it isn’t, and it won’t. We are still in the middle of the Grand Tsunami of bad debt—with the total debt load still some 40% higher than it was in the Great Crash of 1929. Back then, everyone defaulted, initiating what Irving Fisher called a debt deflation. My professor, Hyman Minsky, liked to call this process a “simplification” of the financial system. Finance got downsized and we finally emerged from the Great Depression with virtually no private debt. To be sure, it took WWII to finally jump-start the economy—and then we were off and running through the Golden Age of US capitalism. This time we propped Wall Street up with $25 trillion of bail-outs, guarantees, and loans. We insist that debtors must pay, as we impose what Richard Koo calls a balance sheet recession on our economy, bleeding to death through a million tiny cuts. It is impossible to say how long this slow debt deflation can be drawn out—but with the financial sector on government life support, it could easily continue through the 20-teens.
Meantime, only a philanthropist or a fool would invest on the basis of investment tax deductions to come over the next 10 years. If we are to follow Japan’s example, deflation of asset prices will continue for at least the next decade. There is no harm waiting a few years to see how things shake out. Why invest now when you might simply buy your competitor at fire sale prices five years from now when you actually need more capacity? And even if the President gets more investment now, a couple of hundred billion dollars is not going to create enough jobs to ramp up consumption and to keep families in their homes. The cancer in our real estate sector will continue to spread, and will more than offset any benefit to be realised from the President’s proposal.
Let me be clear. We need public infrastructure spending. And we need corporate tax relief. Indeed, Hyman Minsky always argued for elimination of corporate income taxes. Instead, all corporate profits should be imputed to owners and taxed as personal income. The purpose of this is not to jumpstart the economy or to promote investment. It is to rationalize the tax system. Federal taxes serve three purposes: to discourage “bad” behaviour (pollution, smoking), to remove excessive income from the economy (when it is in danger of overheating—causing inflation), and to “drive” the currency (I will be writing more on this in coming weeks). One could also argue that we should use the tax system to redistribute income and wealth, although this has proven to be little more than a “pious hope” (again, something we can examine later). Corporate taxes fail on all these counts. Certainly, making profits is not a “bad”—it is the goal of the corporation, so we ought not slap the corporate hands that make profits. And the other functions are all better served by taxing the owners.
Is there a better way to deliver tax relief if the purpose is to stimulate the economy, now? What we want to do is to provide relief in a manner that will promote job creation while putting more money into the pockets of workers so that they can spend and pay their bills. It should be quick, easy to administer, and equitable.
The answer is obvious: payroll tax relief. What we need is a payroll tax holiday—stop collecting Social Security taxes until the economy has completely recovered. This can be implemented immediately, it is broad-based, and it directly reduces employment costs.
For most Americans, the payroll tax is a bigger burden than income taxes.
The primary payroll tax is an OASDI (Old Age and Survivors and Disability Insurance—the portion of Social Security taxes, excluding the hospital and supplemental medical insurance portions) tax levied on employees, employers, and the self-employed. The tax rate is 6.2% and imposed on both employer and employee (or 12.4% on the self-employed) up to a maximum taxable base. Approximately 163 million people paid Social Security taxes on earnings in 2007 (before the downturn—that wiped out jobs and lowered revenues). Total tax revenue raised was $656 billion, which amounts to an average of $4025 per taxpayer.
The payroll tax is regressive because incomes above the base are not taxed. Further, the payroll tax is levied only on employment income and not on interest, profit, or capital gains incomes that mostly go to high income households. As a result, taxpayers with wages and salaries below the base pay about 75% of all payroll taxes even though they receive well under half of adjusted gross income. The payroll tax is particularly burdensome for low income households, which are largely exempted from the federal income taxes. In 2005, taxpayers with wage and salary income below $40,000 accounted for about one-third of all payroll tax receipts.
A moratorium on collection of the OASDI portion of the payroll tax would provide immediate tax relief to approximately 160 million workers and their employers, injecting more than $12 billion each week into the economy. Take-home pay would rise by an average of nearly $80 per week for each taxpayer, with an equivalent saving per worker for each employer, lowering the costs of keeping workers on the job.
When the economy recovers, less tax relief may be desired. For this reason, the tax holiday can be phased-out as conditions warrant. For example, if job losses can be reversed over the course of next year, the payroll tax could be restored after net job creation targets are reached. I believe it will be better to err on the side of caution—President Roosevelt’s recovery in the mid 1930s was killed by the original imposition of Social Security taxes, resulting in the sharp downturn in 1937. It is unlikely that restitution of the payroll tax will be needed until 12 million or more jobs are created.
To replace Social Security revenue while the moratorium is in place, the Treasury should directly credit the Social Security Trust Fund—in effect, the Treasury will directly pay for all OASDI benefits during the moratorium. As the payroll tax is gradually phased back in, the Treasury’s contribution will decline. If the payroll tax is returned to 6.2% on both employees and employers once recovery is completed, then OASDI will again run a huge surplus that is reflected as Treasury contributions to the Trust Fund.
This is the right way to do tax relief in a downturn, stimulating employment and consumption. That will then provide the incentive business needs to justify investment in plant and equipment. So, to conclude, I do not oppose the President’s proposal—yes, let us cut corporate taxes, and, yes, let us start to replace our crumbling infrastructure. But we also must get tax relief to employees and employers—and we need to recognise the true scale of the problem at hand.
L. Randall Wray is a Professor of Economics, University of Missouri—Kansas City. A student of Hyman Minsky, his research focuses on monetary and fiscal policy as well as unemployment and job creation. He writes a weekly column for Benzinga every Thursday.
He also blogs at New Economic Perspectives, and is a BrainTruster at New Deal 2.0. He is a senior scholar at the Levy Economics Institute, and has been a visiting professor at the University of Rome (La Sapienza), UNAM (Mexico City), University of Paris (South), and the University of Bologna (Italy).
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