A History and Analysis of Payroll Tax Holidays

Mar 17, 2020 / Amanda Chase, Horsesmouth Assistant Editor

As Congress and the White House consider ways to shore up the economy in the face of a public health crisis, President Donald Trump has suggested suspending the entire payroll tax for the duration of the year. This would cost about $950 billion if the tax is suspended between April 1 and December 31, and if implemented would be a major change in tax policy in terms of revenue and economic effects. A payroll tax cut or suspension may support firms facing liquidity problems and considering layoffs, easing the impact of an economic slowdown. It is important to keep in mind the history and arguments behind payroll tax holidays before moving forward. Payroll tax holidays have a mixed economic record, repeat the problems that plague temporary tax policy more broadly, and may not be the most effective tool for responding to a growing economic downturn.

Back in 1977, the Carter administration enacted a New Jobs Tax Credit which provided a tax credit of 4 percent of Social Security payroll taxes paid by employers, with the aim of encouraging job growth. The credit’s design was complicated and ended up not creating many additional jobs while depriving the Social Security trust fund of revenue. The credit eventually phased out in 1978.

In 2010, the employee-side payroll tax was reduced from 6.2 percent to 4.2 percent for 2011 and 2012 to stimulate the economy. General revenue was used to replace the revenue loss for the Social Security trust fund over those two years. The economic evidence suggests the tax holiday was mostly saved by households, reducing the effectiveness of the holiday as an economic stimulus.

A reduction in or suspension of the payroll tax may accrue to workers in the form of higher wages. The economic effect of the payroll tax holiday depends on which side of the tax is cut. Reductions in the employer-side of the payroll tax may have larger economic effects than reducing employee’s payroll taxes, though the latter also stimulates aggregate demand. An employer-side payroll tax reduction or suspension would ensure greater liquidity for businesses that may otherwise become insolvent in the face of falling demand. While the burden of the payroll tax is borne by employees in the long run, removing it in the short run may give firms room to prevent layoffs or a reduction in investment they would otherwise be forced to make.

A reduction or outright suspension of the payroll tax would not be well-targeted to those most vulnerable to economic disruption. Retirees are not in the labor force and will not benefit from the tax cut. Hourly and low-income workers are more likely to experience job loss. As a fiscal stimulus, payroll tax holidays have a mixed record. The benefits of a payroll tax holiday would accrue to employers and workers over time, spreading out the demand-side effect of the tax change. Payroll taxes appear to provide more fiscal stimulus than an equivalent rebate as households tend to spend more due to a reduction in tax withholding than when they receive a tax rebate. However, payroll tax reductions are not well-targeted toward taxpayers most likely to spend the additional funds (higher-income earners), as higher earners tend to consume less as a proportion of their income.

You can find the full article and analysis at the Tax Foundation.


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