The Less-than-Thrilled Case for Extending the Payroll Tax Holiday

When I think about taxes, my first instinct is to rip up the corrupt internal revenue code and implement a simple and fair flat tax.

When I think about Social Security, my first instinct is to copy dozens of other nations and implement personal retirement accounts.

Unfortunately, the political system rarely generates opportunities to enact big reforms that actually solve problems and increase freedom. Instead, we’re stuck with proposals that make things modestly better or modestly worse.

So you can imagine my sense of dissatisfaction that I’m getting peppered with questions about whether the one-year, two-percentage point payroll tax holiday should be extended.

But it’s more complicated than that. The Democrats in the Senate want to make the temporary tax cut even bigger and “offset” that tax cut with some soak-the-rich tax increases. Republicans, meanwhile, are frozen like deer in the headlights. They understandably don’t like the Democrat plan, but they seem reluctant to support anything else, not even a “clean” extension of the current policy.

Here are a handful of observations.

  • The Democrat’s proposal for a one-year payroll tax cut financed by a permanent income tax hike on investors, entrepreneurs, and small business owners would be a big net negative for U.S. job creation and competitiveness.
  • A “clean” extension of the payroll tax holiday would modestly improve incentives for work, but the temporary nature of the tax cut substantially weakens pro-growth effects.
  • Ideally, the extension of the tax holiday should be financed by reducing the growth of federal spending.
  • There are other tax cuts, such as permanent reductions in marginal income tax rates and/or permanent reductions in the double taxation of saving and investment, that would have a better impact on the economy.
  • There are other tax cuts, such as expanded credits, deductions, preferences, exemptions, and shelters, that have no positive impact on the economy.
  • A payroll tax holiday does not undermine Social Security since the Trust Fund is nothing but a big pile of IOUs.
  • The best incremental reform would be a permanent reduction in the payroll tax, with the money channeled to personal retirement accounts. This would lower the tax burden of work while reducing the long-run burden of entitlement spending.

So what does all this mean? Simply stated, there are many other fiscal reforms that are preferable, but a temporary extension of the payroll tax holiday is better than nothing—assuming, of course, it is not poisoned by accompanying class-warfare tax hikes.