People can afford to pay the government more money in good times but need more money to spend when times are tough
One of the worst things that the government can do is to raise taxes when the economy is struggling. That results in even less money for the private sector to spend and weaker economic activity. So you often see the opposite: legislatures sometimes temporarily cut taxes during a recession to encourage spending and investment. But why not take this idea and mechanize it? Tax rates could be set to move up and down as the economy expands and contracts.
This idea expands upon one offered by former Obama White House budget chief Peter Orszag. In his Bloomberg View column this week, he wrote:
To mitigate the harm to the labor market from this fiscal drag, policy makers should provide additional macroeconomic support in 2012 by extending the existing payroll tax holiday. But more than that, Congress should link the payroll tax to the unemployment rate. This would allow the tax holiday to automatically calibrate itself to existing conditions, providing support only when the economy is weak. If necessary, the underlying payroll tax rate could be raised to make this mechanism budget-neutral.
This is a pretty slick idea. By allowing tax rates to automatically adjust as the economy changes, you do two things. First, you ensure that taxes remain low when the economy needs extra spending and investment. Second, you ensure that the government doesn't become too enamored with ultra-low taxes and keeps them too low for too long after the economy recovers, creating budget deficits.