Tax Lawyer's Blog

Senator Robert Casey, Jr. (D-PA) asked the Congressional Budget Office (CBO) for its input on ways increase employment by reducing payroll taxes. Here’s part of the CBO’s response:

This letter responds to questions you posed about policy options to increase employment by reducing employers’ payroll taxes for firms that increase their payroll.

CBO anticipated that firms would respond to a payroll tax credit through a combination of four channels:

1. Some firms would react to lower employment costs by reducing the prices they charged in order to sell more goods or services. Higher sales would in turn spur production, which would lead to increases in hours worked and hiring.
2. Some firms would pass the tax savings on to their employees in the form of higher wages or other types of compensation, which in turn would encourage more spending by those employees. 
3. Some firms would retain the tax savings as profits, which would be passed on to shareholders.  
4. Some firms would use slightly more labor during the period when it was temporarily less expensive.

CBO seems to view numbers 1, 2 and 4 as positive outcomes and number 3 as a negative outcome. What’s interesting about that is the CBO didn’t point out (as it did in number 2, where it predicted that some employers would use the tax cut to raise the wages of their current employees) that when employers pass on the tax savings to their shareholders that, too, encourages more spending.

Clearly, though, the goal of the payroll tax credit is to encourage employers to hire additional workers. Consequently, numbers 1 and 4 represent the optimal outcomes of the credit and the ones, I assume, Mr. Casey would like to achieve.

Note, though, that the CBO found that even for those employers who do use the credit to directly increase employment, there would only be a slight increase in employment.

(Hat Tip: Paul Caron)

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