Thursday, 2 January 2003

Tax Cuts Galore

Virginia Postrel writes in Wednesday's New York Times on “Tax Policy as a Tool and a Weapon”; go forth and read it.

She mainly discusses the relative merits of changing the tax treatment of dividends, corporate tax reform, and a payroll tax cut. On the latter, she writes:

Reducing the payroll tax would give every worker an immediate tax break and encourage companies to hire (or retain) employees. It's a winning idea whether you're looking for a Keynesian jolt to consumer spending or a supply-side boost to hiring. And it would particularly benefit low-income workers, who pay little or nothing in federal income taxes but still owe payroll taxes.

However, she notes a low-end payroll tax cut — exempting the first $10,000 of income, for example — could have perverse policy implications, by making it more cost effective for employers to hire two workers on a part-time basis than one full-time worker. A cut in the payroll tax rate, as opposed to an exemption, might therefore be economically preferable.

Of course, cutting the payroll tax has other problems associated with it — either future benefits will have to be cut accordingly, or general taxes will have to be diverted to subsidize social security and Medicare; neither option would be very palatable. A solution some have suggested — taxing high-income workers on their full incomes without a corresponding benefit increase — has some appeal to income redistributors but may not be popular with the electorate (and a tax increase is a tax increase, at least in a 15-second sound bite).

One plausible option (speaking as a “policy wonk” rather than a libertarian) is to have a rate cut in the payroll tax, coupled with a new tax in two years (bringing the total rate back to the old rate) tied to privatized accounts. The holiday would serve a useful short-term goal, while the new financing arrangement would kickstart a move toward privatization of social security.