Understanding the payroll tax cut

Part of the bipartisan tax deal is a cut to the payroll tax, a demand-side measure that replaces the “Making Work Pay” tax credit. You can argue all you like about what sort of effect it will have, but I never stop being amused when I see this kind of thinking on taxes:

On Morning Edition, NPR's John Ydstie talked with host Steve Inskeep about the thinking behind the proposed cut. As John said, workers pay that 6.2 percent on annual income up to $106,800. So if you earn a big salary, the cut would put about $2,100 into your pocket over the course of a year.

You get a bit more money in each of your paychecks and it's more likely then that you'll spend it than getting a $1,000 or $2,000 check in the mail, which you might decide to save,” John said. In other words, more money goes back into the still-sluggish economy — which needs some stimulus.

This implies that some kind of psychological trick of timing can somehow improve the economy. It's a ridiculous idea. The fact that there's a smaller bite from your paycheck isn't going to change your existing priorities as a wage-earner. If you're already trying to pay down debt, you'll probably keep paying down debt. If you're already amassing cash, worried about your employment circumstances, you'll probablybe happy to see your bank balance get a bit more padding.

Of course, if you're the sort of person who cashes your paycheck on Friday, determined to spend every dime no matter what, then okay, this line of thinking does apply to you. But how many people live that way? And does their profligacy create economic health?

We watch consumer spending because a huge drop in it tells us that people are scared — right now, they're afraid they might lose their jobs. The large economic players who usually invest in and lend to all corners of the economy have been wiped out by investments in assets whose value has proven illusory. As a result, trillions of dollars in wealth have simply disappeared. The big guys' fear trickles or gushes down to the small guy who works for him or any of the people affected. Some wage-earners have been slammed twice — both as homeowners and as employees who work for companies that have lost wealth.

Economic recovery requires the eradication of fear. And you can't erase consumers' fears by adding $40 or $60 or even $100 to anyone's weekly paycheck, or by giving them a $2,000 check. Besides, consumer spending is not the only thing that matters, or else we could become a much wealthier nation by convincing every American to eat ten ice cream cones every day. Money does not disappear down a black hole when people save or invest. Savings and investments also create jobs by putting money in the hands of businesses and lenders.

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