Does Real Tax Reform Begin With a Payroll Tax Holiday?

Unsatisfied with an economy that's slouching toward recovery, the White House is considering further tax breaks to jump-start buying and hiring, including a payroll tax holiday. What's that?

The payroll tax skims about 15 percent off wages and compensation to pay for Social Security and Medicare. A holiday would be akin to a tax cut about about 7.5 percent for both employees and employers for all salaries up to about $107,000.

 

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MORE ON Payroll Tax Holiday:

  Megan McArdle: Problems with a Payroll Tax Cut

Derek Thompson Holiday! Celebrate?
 

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Good idea? Maybe. Old idea? Definitely. Flash back to a year ago, when Robert Reich was already calling for a holiday on payroll taxes up to $20,000. Flash further back to early 2009, when Senate Minority Leader Mitch McConnell proposed a payroll tax holiday for "one or two years," and Senator John McCain proposed to lop the payroll tax in half for all workers. Flash even further back to December 2008 when the Atlantic's own Michael Kinsley proposed the holiday in TIME. And so forth.

Point is, the idea has been around for a while because it's intuitive. Taxes on work discourage work. Eliminate those taxes, and it makes it easier for employers and employees to get together.

The last time I wrote about a payroll tax holiday, I carved two caveats into the pro argument. First, we already have a limited payroll tax holiday, because under the new HIRE Act, employers don't have to pay payroll taxes on new hires this year. It's unclear how well this is working. Second, there's no guarantee that these stimulating tax cuts will stimulate. Employers might sit on the extra cash, the same way non-financial companies are sitting on $1.8 trillion in cash today. And employees might use the money to pay down debt and pay up savings, as Americans have done with much of the Making Work Pay tax break in the Recovery Act.

Treasury officials I've spoken to have cautioned on numerous occasions that the payroll tax holiday is purely speculative. They've also said that the administration isn't looking to upend the tax system. Too bad. As Hendrik Hertzberg wrote in a wonderful essay, slashing the payroll tax is only one half of a good tax reform.

We fund our government with taxes on things that are good, like income and investment, while we're scared of taxing things that are bad, like excessive pollution and consumption. Replacing part of the payroll tax cut with a VAT or carbon tax would be a smart step toward a tax system that makes sense.

In the short run, a payroll tax holiday will be debated between familiar parameters. Its progressiveness. Its impact on the deficit. Its likelihood to be spent. That's fine, but in the long run I'd like to see a broader debate. Eventually, cutting part of the payroll tax forever might be a holiday worth celebrating.