11/17/2010 07:40 pm ET Updated May 25, 2011

Reconnecting Job Growth to Deficit Reduction - Part 2

In Part 1 of this blog, I overviewed an important new Bipartisan Policy Center (BPC) report on deficit reduction, and pointed out the significance of it leading with a one-year payroll tax holiday for employers and employees to encourage job growth and stimulate the economy. I also noted that this pulls most of the punch out of the real deficit-cutting potential of payroll tax cuts, which given some bigger thinking could enable a more fundamental shift of the tax burden.

Bill Drayton and others have pointed out payroll taxes artificially make hiring too expensive and non-labor production factors (energy, natural resources/materials, land) too cheap, with the result that we underutilize the former and overconsume the latter. Suspend payroll taxes in a temporary holiday as the BPC proposes, and hiring costs come down about 15%. That's good, but we can't afford to absorb the lost revenue for long. Payroll tax is now over 40% of federal revenue, vying with income tax as the largest contributor to funding the government. Government won't function, much less tackle deficits, without that money. But there are much better ways to get it than by taxing employment and cannibalizing job growth.

If we permanently cut payroll taxes and replaced the lost revenue with equivalent non-labor taxes on energy waste, materials waste, pollution, sprawl and other undesirables, we would effectively shift the tax burden off work and onto waste. We could take a page from the Bowles-Simpson proposal for example and offset a payroll tax cut against a gas tax increase to encourage energy efficiency. And/or we could select any combination of many alternative non-labor tax options, for example a non-labor VAT tax.

This sort of revenue-neutral tax swap would lower the relative price of labor vs. non-labor inputs by over 30%, and lead to job creation at the scale of the unemployment problem - tens of millions of jobs as opposed to the 2.5-7 million range the BPC proposal envisions. It would effectively be a free stimulus, answering our clamoring need for bold steps for job and economic growth, without raising taxes or deficits. It would enable other deficit reduction measures to succeed by growing us at least part-way out of the deficit trap, so fiscal policy can take us the rest of the way.

Not incidentally, it would also cease subsidizing and therefore shrink wasteful consumption of non-labor inputs including energy, giving us a "free" way to lower greenhouse gas emissions and put our economy and environment on a more sustainable footing -- all without a net increase in taxes and without more deficit spending.

Even in the current polarized political environment, new taxes on carbon or other carbon pricing mechanisms are getting eyed as potential deficit reduction measures, because they can raise lots of revenue. But to work they would have to be half of a revenue-neutral shift against payroll tax cuts. That way, the cuts would compensate consumers for higher energy prices (payroll taxes are the largest tax 80% of Americans pay and an important factor in household budgets), while also creating many, many more jobs for them. If I were a Congressman from an angry district with high unemployment, that's a deal I'd be inclined to take. I am headed to national conference on pricing carbon this weekend at Wesleyan to make this argument, attended by several members of Congress as well as climate movement leaders like Bill McKibben and Dr. James Hansen.

That's not to say I think Congress's incoming freshman class is ready to vote for payroll tax shifting as a deficit reduction measure. And I don't expect a bipartisan deficit task force to recommend it in its purest form yet, either. But it is a significant sign of the growing currency of the payroll tax-shifting idea that the BPC has frontloaded its proposal with a payroll tax holiday as a necessary bridge between growing the economy and cutting the deficits.