Give Payroll Tax Cuts to Employers, Not Employees

Rather than extend the employee payroll tax cut, the government should give reductions to employers that hire workers. This will do more to boost job creation.

By Scott Shane

In his most recent weekly radio address, President Obama proposed extending the 2011 employee payroll tax cut for another year, reiterating his argument that it will create jobs. I disagree and don’t think it’s worth extending. While Treasury Secretary Timothy Geithner claimed back in January that the payroll tax cut would create 1.5 million new jobs, Joel Prakken of Macroeconomic Advisors says it has created only 300,000, and other observers estimate the number is even lower.

When paying payroll taxes, employers and employees are normally each responsible for half of the 12.4 percent Social Security tax. Last December, Congress passed the President’s proposal to reduce the workers’ share of Social Security taxes to 4.2 percent for 2011. The employer’s share of the taxes remained 6.2 percent, giving them no additional incentive to hire.

If Congress and the Administration want business owners—particularly the small business owners who employ half the private-sector workers in this country—to increase hiring, then they should let the employee payroll tax reduction expire at the end of the year and replace it with an employer-side payroll tax reduction. As the nonpartisan Congressional Budget Office explained to Congress in a January 2010 report, payroll tax cuts boost employment more if they are given to employers rather than employees.

Job Creators Only?

But there may be an even better way of stimulating job growth than an across-the-board payroll tax cut for employers. Some economists have suggested limiting the employer payroll tax cut to only those businesses that create new jobs. There’s a lot of merit in that approach.

Because a targeted tax cut would cost much less than a tax cut for all businesses, lawmakers could reduce payroll taxes on the businesses adding jobs by much more than the 2 percent across-the-board reductions put in place for employees this year. In fact, policymakers could eliminate the entire 6.2 percent employer share of payroll taxes and contribute less to the deficit simply by limiting the tax cut to the businesses boosting hiring.

In addition to wiping out the employer share of payroll taxes, policymakers should offer a tax credit equal to 25 percent of the increase in payrolls, but limit the credit to only those firms that hire more workers. If nearly one-third the cost of new employees was being picked up by the government, businesses would add workers.

Small Biz Incentive

The credit would be meaningful to small business owners who run pass-through businesses where profits and losses are treated as personal income (sole proprietorships and subchapter S corporations). Because the cost of additional hires hits the wallets of these business owners, cutting the cost of those workers would be a powerful incentive.

While the economics of a targeted payroll tax cut for employers is sound, I’m not sure the Administration would go for it. What the Obama Administration liked about the employee payroll tax cut was that the money went to all employed Americans. As ineffective as the policy was at stimulating job creation, cutting taxes on the average American is politically very attractive. A targeted tax cut for only those businesses adding employees, however, goes largely to the successful business owners (they’re the ones most likely to hire).

The New York Times reports that President Obama “is considering expanding payroll-tax relief to employers and a tax credit for new hires.” That’s promising. Of course, I wonder if it will really happen.

Scott Shane is the A. Malachi Mixon III Professor of Entrepreneurial Studies at Case Western Reserve University.