February 3, 2009

Which Tax Cut is Most Progressive and Stimulative?

What do one of our world's wealthiest men, Warren Buffett, and one of America's prominent liberal economists, James Galbraith, have in common?...they both pointedly endorse a certain kind of very progressive tax cut -- a "payroll" tax holiday.

The FICA (payroll) tax is regressive by nature as it taxes only up to a certain level of income, allowing income over $102,000/yr to go FICA-tax-free.

The FICA tax does not apply to capital gains or dividends! (!) Wealthy and living off investments? You pay no FICA taxes on those.

This means the richer you are, the lower your FICA tax rate is.

But the poorest workers, on the lowest wages, pay the full FICA tax all the way.

The reason a payroll tax holiday is especially stimulative is because this tax cut goes primarily to lower income households, who by nature must spend more of their tax cut just to get by.

A FICA tax holiday would also help small business owners and individuals working for themselves.

Again, these are people who need the money especially now, and who will spend it soon.

For instance, it's estimated that the multiplier of a payroll tax cut is very nearly as high as the multiplier of federal aid to state budgets which save state jobs as state revenues fall.

How long should a FICA tax holiday last?

Until the economy recovers strongly.


  1. Strongly agreed. FICA stands as a disincentive both to work, and to employ. Lowering or eliminating it would encourage "welfare" recipients to work, and it would encourage business owners to hire.

    The natural flow of wealth is from those without, who generate value to those with who consume value. If you want to increase a river's flow, you do not dump water in the ocean.

  2. This is all true, but it begs one huge question: what about the Social Security (and especially the Medicare) entitlements? Any payroll tax holiday would have to have one of two things associated with it, either:

    1. An absolutely ironclad sunset date, because once the FICA tax goes away, NO ONE will want it ever to come back; or

    2. Some other unassailable way to fund Social Security and (especially) Medicare.

    Got any ideas??

  3. hedera, I've a draft of some solutions for the long term federal budget balance. About Social Security a key insight is to realize that magic number of retirement at 65 is from an age where people did not live so long as now. Becuase we live much longer we inevitably must work at least part of that extra time, or make do with an extremely modest amount of benefits. I'd prefer the former, but the age steps already offer everyone a choice of when to retire. One solution of a sort is simply for the SSadmin to refine the numbers of how much benefits you'd actually get at certain retirement age points and emphasize those a bit more, and let people choose.