Carney: A Payroll Tax Cut Would Give Americans the Raise They Deserve

The time is right for a payroll tax cut.

The Trump administration has reportedly considered implementing a temporary cut to payroll taxes in an effort to push economic growth higher and ward off fears of a recession. This would reduce or eliminate the 6.2 percent tax American workers pay into the Social Security system, immediately raising take-home pay by reducing withholding.

It is likely that such a tax break would significantly boost consumer spending, particularly if implemented as we head into the holiday season. This kind of fiscal stimulus would be more effective in the near term than a Federal Reserve rate cut, which most economists think only boosts the economy after a significant time lag. And it would offset the stubbornly low wage growth that has persisted despite very low unemployment.

Some economic theory suggests that any response to a temporary boost to income should be small. The idea is that consumer spending is conditioned not by actual income but by expectations of future income. So when consumers know that they are just getting a temporary bump, they’ll tend to save it or use it to pay down debt.

Some economists even insist that there would be no additional spending at all. Because a tax cut now enlarges the deficit, consumers just save the income in anticipation of having to pay higher taxes later.

But research by the Federal Reserve Bank of New York into the Obama era payroll tax cut indicates that the cut was effective at boosting spending. Indeed, workers spent even more of their additional income than they expected to.

The Fed study was based on two surveys, one taken right after the tax cut kicked in and the second after its first year. The first asked what they planned to do with their extra take-home pay. The second asked what they actually did with it.

What they found was that while consumers said they expected to spend only about 14 percent of the tax-break income, they actually had spent 36 percent. While just 12 percent of households said they expected to spend most of the funds, actually 35 percent did.

It appears that the format of the tax cut may have made it more effective than other temporary boosts, such as lump-sum payments in the form of rebates or refunds. Boosting paychecks may be the best way to get Americans to spend more.

It is likely that a payroll tax hike could be even more effective now than it was in the Obama administration. Back in 2010, American households were far more burdened with debt than they are now. Debt service payments took up 11.7 percent of U.S. disposable income. Today that number is 9.9 percent. That meant more of the income got diverted to paying down debt in 2010 than it would today.

And we had just emerged from a recession and a terrifying financial crisis. Consumer confidence was cratering. In March of 2010, the Conference Board’s index of consumer confidence fell to 52.3. It cratered again in June. Many Americans were fearful that we could fall deeper into recession rather than grow the economy again. In that atmosphere, saving and paying down debt seemed like a prudent idea.

That stands in sharp contrast with today. While there are lots of scary headlines saying recession risk is on the rise, the economy is very healthy and consumer confidence is still riding high. Given a boost in paychecks, consumers are likely to spend even more today than they did when Obama cut the payroll tax.

Of course, implementing economic stimulus measures is a tricky thing, because they can backfire if consumers view the stimulus as a sign of economic distress. In fact, Yale economist Robert Shiller told CNBC on Tuesday that he thinks the Fed’s July rate cut may have hurt more than helped because it raised fears of a recession.

That’s likely one reason some in the Trump White House are denying that the administration is considering a payroll tax cut. They do not want to look panicked.

That seems ill-advised. Our financial news outlets are already obsessed with the risk of a recession. Political pundits are even worse, all but declaring a recession would be welcome to oust President Trump.

Bold action in the form of a tax cut now may not scare Americans so much as reassure them that the Trump administration remains dedicated to making the American economy great again.