Pay Roll Tax Relief Makes No Economic Sense

People with a grip on reality have seen this from the very beginning of our down ward spiral. Ronney Reagan saw cutting taxes works and proved it with huge growth in GDP over more than three decades.

It's only recently that the politicians have decided that if we are more compassionate toward those that are struggling will we be more prosperous. 'A rising tide lifts all ships' has been lost some place in the transition to 'leveling the playing field'.

Global Evidence on Taxes and Economic Growth: Payroll Taxes Have No Effect
Source: William McBride, "Global Evidence on Taxes and Economic Growth: Payroll Taxes Have No Effect," Tax Foundation, February 8, 2012.

Congress is currently debating whether to extend throughout the year the payroll tax holiday, which is currently set to expire at the end of February. Proponents of the holiday argue that the economic recovery is fragile, that continued short-term stimulus is in order as a result, and that the payroll tax holiday is particularly effective in this regard because it puts cash in the pockets of those most likely to spend it.

While there is a certain appeal to this argument, many economists have a different view of the short-run dynamics of stimulus measures in general and this payroll tax holiday in particular, says William McBride, an economist at the Tax Foundation.

The long-term growth effects of a payroll tax holiday extension are worth considering as well, as the United States appears mired in a long run of slow growth.

Here the evidence is quite conclusive: Based on Organization for Economic Cooperation and Development (OECD) data on 34 member countries between 2000 and 2010, there is no significant relationship between payroll taxes and long-term economic growth. In contrast, corporate income taxes have a highly significant and negative effect on long-term growth.

The estimates suggest that cutting the corporate rate by 10 percentage points is associated with an increase in total real gross domestic product (GDP) growth of 11.1 percentage points over the period. This would move the United States from below average to above average in terms of economic growth among OECD countries.

Personal income taxes on high incomes also have a significant negative effect on growth, such that cutting the rate by 10 percentage points is associated with an increase in total real GDP growth of 7.5 percentage points over the period. This would bring the United States to roughly an average level of growth relative to OECD peers.

If lawmakers want to have the biggest impact on boosting long-term economic growth in the United States, they should turn their attention to cutting tax rates on corporate and individual income.