Payroll taxes (V1)

Krugman comments on the politics around the payroll tax, and reminds us that "Milton Friedman’s permanent income hypothesis tells us that much of such cuts will be saved, not spent." This makes the case for spending based stimulus much stronger. The long term unemployed are having significant trouble finding work. After some threshold they can reasonably assume their future employment income to be zero. However, once they are back in the work force, they have reentered the ranks of the employed and can reasonably expect continuous work until their retirement. The result is that their lifetime income has increased dramatically and they can be expected to spend a large portion of their wages. There is a little model below the fold.

Ineffective policy recommendations.

I heard an important story on Market Place today. The story highlighted the long lasting negative impact that a slow start to one's career can have. Recent grads--and by recent we mean 2008 onwards--are having trouble entering the workforce, and hence we've handicapped a generation. Ok, this story is pretty well known, but it's good to hear it publicized.

What blew me away was the solution: "We could, for example, exempt workers under 25 from paying their share of the Social Security payroll tax."

Something tells me that he doesn't fully understand incentives. When unemployment for a group is nearly double the national average, you can safely infer that the problem is not a lazy workforce. Cutting taxes on workers might increase the supply of workers, but it will do nothing to increase demand for them. Oh, and to get back to intertemporal smoothing, a member of the workforce may reasonably see the recent behavior by the government as a willingness to reneg on social security, and may further interpret specific cuts in their payroll tax as a chance to exclude them from future benefits. This reduces their incentive to rack up working years (even at a low wage), and may actually have the exact opposite impact of what he intends.

Cutting the employer portion of the payroll tax may be a different story, but the reality is that the marginal cost of a recent grad is already pretty low. Making additional employees profitable would do a lot more.