Permanent vs. temporary tax cuts

One frequent criticism of the payroll tax cut is that because it is temporary,  it will have little effect on investments. However, depending on its length, it will still have an effect on shorter term investments.

Haraz N. Ghanbari/AP/File
In this December 2011 file photo, President Barack Obama signs the payroll tax cut extension, in the Oval Office of the White House in Washington. Karlsson argues that critics of the payroll tax cut's temporary nature are overlooking the effect it can have in a short period of time.

One criticism against the payroll tax cut that has frequently been made from conservative and libertarian economists is that it is temporary, and because people supposedly make decisions on permanent conditions it will have no effect.

This argument has a limited degree of truth in it as it is true that if taxation of investments are reduced by say 5 percentage points for one year, it will have less effect on investments that last more than a year than a "permanent" tax rate reduction of 5 percentage points. Just how great the difference is depends on how long the investment will last (the longer, the greater difference it makes).

However, because total after tax return still rises, it will still promote any investments that generates profits within a year.

Furthermore, the payroll tax reduction isn't about investments, at least not directly, it instead has a positive effect in the form of boosting labor supply, something that increases employment in part through a reduction in frictional unemployment and in part by lowering labor costs. Given the limited degree of wage rigidity that exists cutting the employer's share of the payroll tax cut would have been more effective, but

But don't businesses hire people based on long-term factors? Well, they often do, but there is no rational reason for them not take advantage of temporarily lower labor costs by hiring people temporarily given that America's flexible "hire and fire" laws makes it very easy and costless to fire employees.

Furthermore, it should be noted that no tax rate is really permanent (which is why I've put quotation marks around it except here) since they can, and very frequently have historically been change. While a "permanent" change is in the United States somewhat more difficult to change due to the fact that the two chambers of Congress and the President can usually block them if they want, that is as the historical record illustrates a difference of degree, not kind.

The real problem with temporary instead of "permanent" tax cuts isn't therefore so much that the short term effect is smaller. The real problem is that once the tax cuts expire, the positive effects will expire too, meaning that it will lower future growth, largely cancelling out the short term positive effect.

You've read  of  free articles. Subscribe to continue.

Dear Reader,

About a year ago, I happened upon this statement about the Monitor in the Harvard Business Review – under the charming heading of “do things that don’t interest you”:

“Many things that end up” being meaningful, writes social scientist Joseph Grenny, “have come from conference workshops, articles, or online videos that began as a chore and ended with an insight. My work in Kenya, for example, was heavily influenced by a Christian Science Monitor article I had forced myself to read 10 years earlier. Sometimes, we call things ‘boring’ simply because they lie outside the box we are currently in.”

If you were to come up with a punchline to a joke about the Monitor, that would probably be it. We’re seen as being global, fair, insightful, and perhaps a bit too earnest. We’re the bran muffin of journalism.

But you know what? We change lives. And I’m going to argue that we change lives precisely because we force open that too-small box that most human beings think they live in.

The Monitor is a peculiar little publication that’s hard for the world to figure out. We’re run by a church, but we’re not only for church members and we’re not about converting people. We’re known as being fair even as the world becomes as polarized as at any time since the newspaper’s founding in 1908.

We have a mission beyond circulation, we want to bridge divides. We’re about kicking down the door of thought everywhere and saying, “You are bigger and more capable than you realize. And we can prove it.”

If you’re looking for bran muffin journalism, you can subscribe to the Monitor for $15. You’ll get the Monitor Weekly magazine, the Monitor Daily email, and unlimited access to CSMonitor.com.