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'America Needs Jobs' Idea No. 1: A Payroll Tax Holiday

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(Part of the America Needs Jobs series.)

The only reason we still have a payroll tax is because it's been specifically used to fund the two most successful and progressive social programs in American history: Social Security and Medicare.

Otherwise, we would have gotten rid of it ages ago. On its own, it's the most regressive tax imaginable: 12.4% of your salary (typically split between you and your employer) no matter how little you make, and capped at an annual salary of $106,800.

So for a millionaire, it's nothing; for the working poor, it's an enormous wallop. And worst of all -- especially in a period of widespread joblessness -- it is literally a tax on employment.

As Philip Klein writes in the American Spectator (explaining why Republican Indiana Gov. Mitch Daniels supports an emergency one-year suspension or reduction in the Social Security payroll tax):

A reduction in the payroll tax would boost the economy in several ways. Like any reduction in taxes, it would mean that individuals would be able to keep more of their earnings, and thus have more money to inject into the economy. But the unique aspect of the payroll tax is that it's also paid by employers -- it is, in fact, a tax on employment. If you were to lower or eliminate the payroll tax for a period, it would make it effectively cheaper for businesses to hire new workers, or to at least maintain their current workers, until the economy improves.

Earlier this month, the White House was said to be seriously considering a payroll tax holiday before dropping the idea, apparently because it might have muddied the Democratic message on Social Security.

There are different visions of how a payroll tax holiday would work. Liberals focus on reducing the employee contribution; conservatives on the employer contribution. You could conceivably suspend either or both.

Suspending both would result in employees getting a bigger paycheck even as the employer pays out less. So far, everyone seems to agree that the missing tax revenues would be paid into the Social Security Trust Fund from other sources.

When it was still being discussed at the White House, staffers were said to have been debating a range of options, such as applying it only to new hires or limiting it to small businesses.

There's already one form of payroll tax holiday on the books: Any private-sector employer hiring a worker who has been unemployed for at least 60 days does not have to pay the 6.2 percent Social Security payroll tax on that employee for the duration of 2010.

Historically, the idea has been championed by the right, which in and of itself makes the left suspicious -- particularly when Social Security is involved. Some liberals also have qualms about distribution. Chye-Ching Huang of the Center on Budget and Policy Priorities points out that higher-paid workers would get more money back than lower-paid ones, and calls the employer part of it an "inefficient windfall" for businesses.

But others, like James Galbraith of the University of Texas are very supportive -- especially if the Social Security Trust Fund is made whole by increasing taxes on the rich and on estates.

"The policy of tax relief for workers should remain in place until unemployment falls below six percent, at which time it can be gradually phased out," Galbraith writes. "Tax relief for the wealthy is a failed strategy that should end now; a higher personal tax rate will induce companies to retain and invest their earnings, as they used to do."

Over at the American Enterprise Institute, they've been flogging the payroll tax for a while. John H. Makin wrote back in December 2008:

The best available fiscal policy measure would be a sharp reduction in the payroll tax, which would boost household disposable income while giving firms an incentive to retain more workers on their payrolls. Total annual collections from households and firms of payroll tax levies total about $625 billion, about 7 percent of disposable personal income. A payroll tax is labeled as the primary means to finance Social Security and Medicare benefits, but those benefits are financed out of government revenues and would, of course, continue to be provided at their full level. The payroll tax is a poorly designed fiscal measure because it acts as a tax on employing labor and, in times of falling demand, a tax on retaining labor. The payroll tax is the primary tax paid by more than 60 percent of American households and so constitutes a marginal disincentive to further work.

If the payroll tax (of which households pay half directly) were suspended--say, for a year or eighteen months--households would experience an immediate 3.5 percent increase in disposable income that they could employ to sustain consumption and pay down debts. Since the payroll tax is regressive, falling more heavily on lower income households, its repeal would be progressive, while transferring a substantial increase in disposable income to the low-income households who are likely to need it most and therefore likely to spend most of it.

For firms, a reduction in their payroll tax payments would reduce their incentive to lay off workers by reducing the cost of keeping workers on the payroll. In effect, firms would be prompted to shift more toward labor as a factor of production because of a reduction in the tax on employment of labor that the payroll tax entails.

Even Nouriel Roubini, co-founder and chairman of Roubini Global Economics, is optimistic about the payroll tax holiday's effects. The man nicknamed "Dr. Doom" writes:

The argument that increased demand for capital leads to greater demand for labor (i.e., if you buy more machines you need workers to run them) has not held up. Firms are investing in capital goods, equipment and offshore offices that allow them to produce the same amount of goods with less -- and lower labor costs. To avoid a chronic increase in the unemployment rate, we need to subsidize the demand for labor -- achieving job creation -- rather than making it cheaper to buy capital, as investment and other tax credits would do....

To maximize the incentives for private-sector hiring, there should be sharper reductions to the payroll taxes paid by employers than for those paid by employees....

Low-income workers have historically shown a much higher propensity to consume when given extra money, so the payroll tax cut should be designed to provide a larger-percentage break to those on the low end of the income scale compared with the upper middle class.

On Monday, at a CNBC town hall, host John Harwood asked President Obama about a payroll tax holiday.

"Well, this is something that we've examined," Obama said. "And we are going to be working with businesses to see does it make sense for us to initiate some additional incentives in order to hire."

So, Harwood followed up, does that mean the idea is still in play? Obama wouldn't say.

TOMORROW IN THE AMERICA NEEDS JOBS SERIES: More Money For State And Local Governments

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Dan Froomkin is senior Washington correspondent for the Huffington Post. You can send him an e-mail, bookmark his page; subscribe to his RSS feed, follow him on Twitter, friend him on Facebook, and/or become a fan and get e-mail alerts when he writes.