Some progressives have blasted President Barack Obama for letting payroll taxes rise. Critics argue that the economy will suffer because the president and Congress have allowed the temporary tax break to expire.
Yet there's a body of economic research analyzing the difference between permanent and temporary tax cuts that suggests these fears are overblown -- and that the positive economic impact of making most of the Bush income tax cuts permanent could even more than offset the negative impact of letting the short-term payroll tax cut expire.
According to several economics papers, permanent tax cuts boost the economy more than temporary tax cuts. That's because people tend to save the money from a temporary tax cut or use it to pay down debt. In other words, they treat it as a one-time windfall and don't change their spending decisions in response. Because they don't use much of that money to buy goods and services, they don't boost other people's paychecks or spur hiring.
The "fiscal cliff" deal gives middle-class Americans just such a permanent tax break. Obama and Congress have made the Bush tax cuts -- which have been temporary since 2001 -- permanent for couples' income below $450,000 and individuals' income below $400,000. For income above those levels, the Bush tax cuts have expired. Congressional Republicans had fought to make the Bush tax cuts permanent for all income levels, although House GOP leaders proposed letting the payroll tax cut expire.
Joel Slemrod, an economics professor and tax expert at the University of Michigan, told The Huffington Post that people "probably spend a third or less" of temporary tax cuts. A paper he co-wrote found that only 13 percent of households said they would spend most of the 2009 Making Work Pay tax credit, a temporary stimulus measure similar to the payroll tax cut that just expired.
"It had a modest impact," Slemrod said. "Not zero."
A separate paper co-written by Slemrod found that people on average spent only one-third of a 2008 tax rebate, which "provided only a modest stimulus." (That's open for debate. Another study found that Americans on average spent the majority of the 2008 tax rebate.)
Three in four Americans said in 2001 and 2002 that they would save most of a tax rebate or use it to pay down debt, according to yet another study co-written by Slemrod.
If temporary tax cuts don't increase consumer spending very much, they can't help hiring much either. A temporary payroll tax cut in Finland did not boost job growth or wages, according to a 2011 study.
Economic research has found that permanent tax cuts are more effective. A temporary tax change has only half the economic impact of a permanent tax change, according to a study by Princeton economist Alan Blinder. Permanent tax cuts on average increase spending 10 times more than temporary tax cuts, according to a study in Japan. And according to a recent paper analyzing U.S. tax changes between 1950 and 2005, permanent tax changes generally boost economic output more than temporary changes.
Looking forward, Slemrod said that the distinction between temporary and permanent tax cuts may no longer be meaningful. "There are so many tax policy changes it may be that nobody thinks that a tax policy change is permanent," he said.
Obama seems to think that tax cuts can boost the economy. One-third of his 2009 stimulus package consisted of tax cuts. Now, by signing off on a deal to make most of the Bush tax cuts permanent, the president may have sought to provide another stimulus.