Payroll Tax Cuts Are Worst Way To Boost Growth

 

IBDEditorials.com

Fiscal Policy: Intense talks are underway to extend last year's 2% payroll tax cut set to expire at the end of February. Proponents argue it's badly needed to boost the economy, but the evidence suggests otherwise.

Democrats who back the payroll cut — even as it adds hundreds of billions of dollars to our nation's debt — argue it's needed to keep the recovery from stalling. Despite a huge $160 billion cost in 2012, they say, it's worth every penny.

We like tax cuts as much as anyone. But the fact is, we're taking money from a pay-as-you-go retirement system that's already running in the red, and replacing that cash with IOUs. We're burdening future generations so we can spend tax cuts now.

That might not be so bad if payroll tax cuts paid an economic dividend. But a new study by the nonpartisan Tax Foundation suggests they don't. "Based on OECD data on 34-member countries between 2000 and 2010," the study said, "there is no significant relationship between payroll taxes and long-term economic growth."

That's right: no effect. Even so, cutting the payroll tax from 6.2% to 4.2% last year was highly popular, particularly among Democrats. Why? The payroll tax is highly regressive, so the biggest cuts go to low and middle incomes — a favored Democratic bloc. All told, the cuts reach 160 million Americans.

Unfortunately, according to Tax Foundation economist Will McBride, cutting payroll taxes is the worst way to give the economy a boost. Over the 10 years of his study, payroll tax cuts yielded little or no growth.

But does that mean tax cuts don't matter? Hardly. It depends on which taxes you cut. Cutting income tax rates by 10 percentage points, for instance, resulted in a rise in real GDP of 7.5 percentage points. Not bad.

An even bigger bang comes from cutting corporate tax rates. A 10-point cut in the corporate rate, the study found, boosts GDP by a hefty 11.1 percentage points.

Today, American companies pay a total tax rate of 39% — among the highest of all OECD nations. A back-of-the-envelope calculation suggests trimming that rate by 10 percentage points would boost total real U.S. GDP by $1.5 trillion over the next decade — or roughly $4,800 for every man, woman and child.

This is important, since the U.S. economy's growth has lagged the rest of the OECD during the past decade. From 2000 to 2010, the average OECD nation saw real output expand 25%. The U.S. grew just 17%.

"The fastest-growing economies in the OECD all have below-average tax rates on both corporate and high-income earners," McBride says. "The only one of the three major taxes where the U.S. boasts a lower rate is payroll — the one that matters least for long-term growth."

In short, if we really want to grow, we should be slashing income and corporate taxes, not payroll taxes. It would be nice if Democrats in Congress and the White House recognized this.

Sure, playing politics with payroll tax cuts may get you re-elected. But it doesn't do anything for the economy.