Undead on Arrival: Why Payroll Tax Cuts Keep Coming Back -- Part 2

09/29/2010 05:05 pm ET | Updated May 25, 2011

In Part 1 of this blog I argued that despite the defeat of the latest jobs bill in the Senate, seen in historical context, support for the once-taboo idea of cutting payroll taxes is actually steadily growing, and that we're likely to see more, and more ambitious, such proposals in the future. Here's a brief recent (domestic) history of the idea:

For decades MacArthur Fellow and pioneering social entrepreneur Bill Drayton presciently argued that our unemployment problems are not transient effects of the business cycle or lagging indicators of recovery, but fundamental, structural, and worsening, affecting tens of millions of hidden unemployed whose ranks are growing, and that we urgently need to cut payroll taxes and replace them in a revenue-neutral way with other non-labor taxes in order to reverse labor price distortions and unleash job growth.

That would effectively shift the relative prices of labor vs. non-labor production factors 30% or more, correcting the tax-engendered distortions in the way we currently value labor vs. non-labor production values, making hiring much more attractive and bringing tens of millions back into the workforce.

Payroll taxes have ballooned from 1% of federal revenue at their inception to 35% in our time, rivaling income tax revenues. They are the largest tax 80% of Americans pay, as well as the most regressive. So for decades now, we have financed a large portion of the federal budget by artificially raising hiring costs and sacrificing job growth.

Through many recessions and many jobless recoveries, the "third rail" pendulum eventually slowed, stopped and started to swing back towards the dawn of the new idea that our unsustainable reliance on payroll taxes just might have something to do with high unemployment, and that we should amend it.

At first the swing was discernible in certain early adapters and outliers in both parties who began to float the idea of cutting payroll taxes to create jobs. Al Gore's 1992 book Earth In the Balance hinted strongly at it when he argued for a "CO2 tax completely offset by reductions in other taxes." He later made it clear those other taxes should be payroll taxes. Clinton's Comptroller of the US Currency Eugene Ludwig argued for cutting payroll taxes and replacing the revenue with non-labor taxes as the best way to maximize employment and an alternative to sole reliance on Greenspan's Federal Reserve keeping interest rates artificially low.

During the Bush administration certain progressives and conservatives, from then Senator Jon Corzine (D-NJ) to Bush's National Economic Council head Lawrence Lindsay, favored payroll tax cuts as a superior jobs stimulus. In 2004, during a gasoline price spike there was a noticeable convergence of conservative and progressive economists and columnists, from Thomas Friedman to Charles Krauthammer, arguing that we should raise gas taxes to avoid windfalls for foreign oil producers, and offset them with payroll tax cuts to create jobs. In 2008 T. Boone Pickens launched one similar proposal, Richard Lugar another in early 2009.

Throughout these years, despite occasional support for short-term payroll tax holidays, the general policy bias remained, as always, towards incrementally raising, rather than lowering, payroll taxes. The Obama administration is said to be skeptical about cutting payroll taxes because it would undercut entitlement funding (a rationale Paul Krugman dismisses). Yet Obama has actually presided over serious budget and legislative efforts to cut payroll taxes and replace them with other taxes.

Obama's stimulus package included the Making Work Pay payroll tax credit. The 2010 White House budget proposal included a large payroll tax swap: using about $500 billion in cap-and-trade revenues over 10 years to make MWP permanent (Blue Dog Democrats nixed that in favor of pay-as-you-go requirements, and now MWP is unlikely to be extended for 2011). The HIRE act of 2010 gave payroll tax exemptions to employers who hire previously unemployed workers before the end of the year. In 2009 both Rep. John Inglis (R-SC) and Rep. John Larson (D-CT) proposed separate bills imposing a revenue-neutral carbon tax, swapping the revenue for deep payroll tax cuts to create jobs. And although the latest payroll tax cutting measure was limited and died in the Senate yesterday, it was still supported by a simple majority, and there is growing support from leading economists like Nouriel Roubini and Nigel Gault for much more substantial payroll tax cuts to stimulate both hiring and spending.

It's true that tax innovators run political risks these days. Inglis lost his primary to a Tea Party candidate, and it remains to be seen how the conservative backlash will impact this trend towards payroll tax cuts and swaps. On the other hand, there is no lack of conservative champions of payroll tax cuts, from the American Enterprise Institute to Indiana Governor Mitch Daniels. Election-year gridlock and volatility notwithstanding, payroll tax cuts have climbed higher on the political agenda than ever before, and they're still climbing.