Payroll Tax Holiday With a Twist

by: David Beckworth
There is a lot of chatter right now about whether a payroll tax holiday would provide an effective stimulus to the slumbering U.S. economy. The motivation for this chatter is the news that the White House is considering, among other things, some kind of payroll tax cut. The discussion so far has been mixed with some folks like Scott Sumner, Tyler Cowen, and Arnold Kling endorsing it while others like Megan Mcardle and Mark Thoma expressing uncertainty as to how much stimulus it would actually provide. Mark Thoma concludes his discussion of this proposed tax cut with the following:

Thus, the overall effect on employment depends upon the net effect of the AD and AS shifts. If the AD shift dominates, as I suspect it would, it's still possible for this policy to have positive effects on output and employment. But the size of the effect depends upon the strength of the demand side shift, and how strong the shift would be is an open question, particularly given the degree of household balance sheet rebuilding we are seeing which causes the tax cuts to be saved rather than spent.

See the rest of Thoma's post as to why a payroll tax could affect both aggregate supply (AS) and aggregate demand (AD). One way to make sure the AD effect dominates would be to do the payroll tax holiday in the manner I suggested a few days ago: have the Federal Reserve fund the payroll tax holiday with a "monetary gift" to the Treasury department and at the same time commit the Fed to doing so until a certain nominal target (e.g. a price level target) is hit. As discussed in the comments in my previous post, only part of this funding would truly be a "monetary gift" from the Fed. Still, the announcement of a nominal target to complement the payroll tax holiday would go a long ways in stabilizing the nominal expectations.
With all that said, I am not advocating this approach as my first-best solution. I would rather go with more aggressive monetary policy along the lines Scott Sumner discusses here. If, however, there is going to be a payroll tax holiday, why not make it more effective by bringing in the Fed's money helicopter? The biggest impediment to this proposal is a legal one, it would require Congressional approval.

I overstated Tyler Cowen support for the payroll tax cut.