Response to Nouriel Roubini on "America Needs a Payroll Tax Cut"

Nouriel Roubini makes the case What America needs is a payroll tax cut.

Nearly three years since the onset of the financial crisis, the continued weakness of the labor and real estate markets, U.S. consumers' unbalanced balance sheets and fading support from policy stimulus have transformed the risk of a double-dip recession from unlikely to about a 40 percent likelihood.

The administration knows that it needs to fashion a revenue-neutral fiscal stimulus that increases labor demand and consumption. Its proposal to make permanent a research and development tax credit that dates to the 1980s, and then to enact a temporary investment tax credit allowing firms to write down capital investments at 100 percent of cost, are welcome -- but too modest a cure for what ails the economy.

A much better option is for the administration to reduce the payroll tax for two years. The reduced labor costs would lead employers to hire more; for employees, the increased take-home pay would boost much-needed economic consumption and advance the still-crucial process of deleveraging households (paying down credit card debt and other legacies of the easy-credit years).

Proportion is critical in designing the payroll tax cuts. Small and medium-size enterprises have had it rough the past three years. They are scrambling for operating capital as banks hold reserves tightly, and they face higher borrowing costs than large corporations when they do find willing lenders. To maximize the incentives for private-sector hiring, there should be sharper reductions to the payroll taxes paid by employers than for those paid by employees.

Low-income workers have historically shown a much higher propensity to consume when given extra money, so the payroll tax cut should be designed to provide a larger-percentage break to those on the low end of the income scale compared with the upper middle class.

Stimulating Production a Mistake at this Juncture

Certainly some of what Roubini says makes sense. For example, it makes little sense to stimulate capital expenditures and production when there is a glut of overcapacity already.

Unwarranted stimulating of production is one of the reasons tax credits for news homes fell flat on its face. The last thing we needed to do was encourage homebuilders to build more houses.

What Roubini misses is that attempts to stimulate hiring (thus production) won't work because businesses will not hire just to get a tax break. There has to be a legitimate need for businesses to hire. For there to be a legitimate need, there has to be genuine consumer demand.

Plight of Small Businesses

I have written extensively about the plight of small businesses. Here are some examples.

• August 03, 2010: Wells Fargo/Gallup Small Business Index Hits Record Low, Future Expectations Dip Below Zero First Time Ever


• August 20, 2010: Small Businesses are Not Hiring - Why Should They?


• August 24, 2010: Another Atlas Shrugs - Small Business Owners Chime In


• September 06: Labor Day Insanity from Clinton's Secretary of Labor
  

For several quarters, the number one problem in every NFIB report is lack of customers.

The number two and number three problems are Obama's healthcare "solution" and business uncertainty in general.

While business tax reductions will help profits, payroll tax reductions will not address the underlying structural problems, nor will they address the problem of too few customers. A look at the math will show why.

Employer Tax Break Math

If we completely eliminated the U.S. federal payroll tax employer contribution it would save employers 6.2% for Social Security (for wages up to $106,800 and nothing after that), and precisely 1.45% for Medicare.

Will a Pizza Hut, Home Depot, Citigroup, Bank of America, home builder, or specialized small manufacturer hire someone because of tax breaks? Would anyone?

I think not. The maximum possible saving, assuming we forgave all employer contributions, is 7.65%. Health care costs have been going up more than that!

Unless and until businesses can add employees that will increase the bottom line, they won't hire, tax breaks or not. Perhaps it will make a difference for some marginal businesses sitting on the fence wondering if they should hire one more employee, but that is the practical extent of it.

In a sense, the proposal is something like firing a shotgun over a swamp hoping to kill mosquitoes.

Arguably, payroll tax reductions will keep some marginal businesses alive, preventing layoffs. Then again, marginal businesses need to go out of business. Keeping them alive is a bad thing.

Proposal Helps Wall Street More Than Main Street

Lowering employer payroll taxes certainly will help business profits, but that does not mean businesses will hire. In fact, as noted above, they won't.

Thus, Roubini's proposal, as weighted, would help Wall Street more than Main Street. It addresses the symptoms and not the disease.

Consumer Attitudes Are The Key

Let's turn to the consumer side of the proposal. The #1 factor affecting small businesses is lack of customers. Would cutting taxes for the average Joe encourage more spending?

Ultimately one can count on it. Initially, many consumers will take every cent and pay down debt. However, paying down debt is a good thing. Over time, as consumer balance sheets are repaired, people will spend. More spending will promote hiring.

Philosophically Speaking, I Like Business Tax Cuts

Philosophically speaking, I am all in favor of businesses keeping more money and consumers keeping more money. The less money that goes to Washington the better. However, we must look at the proposal as laid out, to see if it meets the stated objective of stimulating the economy and getting businesses to hire.

Targeting businesses with payroll tax reductions will not do nearly as much as middle class tax cuts.

Complete Economic Overhaul Needed

Unfortunately, there is no simple solution to this mess. Structural problems run deep and a complete economic overhaul is in order. Here are a few of the structural problems.

• The US can no longer afford to be the world's policeman. Military spending has to be reined in.
• Public unions have bankrupted many cities and states. The complete dismantling of public unions is mandatory for the long-term fiscal health of the country.
• To stimulate hiring and reduce the cost of government expenditures, we need to scrap Davis-Bacon.
• We do need to reduce business taxes, but only if we can pay for it. I propose we pay for it by slashing military spending.
• We need to fix the corporate income tax structure that gives incentives to businesses to move jobs overseas. Because of tax deferments, businesses pay less tax overseas than in the US. To promote hiring in the US we need to reverse that setup.
• Health care is an abomination. We need to start over from scratch.
• We need to eliminate too big to fail.
• We need to abolish the Fed.
• We desperately need a balanced budget amendment.
  

The public pension mess is nearly beyond belief. Extend-and-pretend not only affects banks, but public pension plans to the tune of $3 trillion. Please see Recently Introduced Actuarially Unsound Methods Hide Pension Mess in Illinois, Texas, Ohio; $3 Trillion Pension Deficit for a discussion.

The Goals

The goals must be a sound currency, a balanced budget, and less government, not more.

We can follow the path of Japan and its two lost decades, or we can make tough choices for the long haul. Sadly, the US has One Lost Decade Already with Another One in Progress Now.

There are no short-term fixes, nor are there painless solutions.

Unless and until we address our structural issues, the economic crises will not go away.

I am all in favor of incremental progress along the way, but a payroll tax cut is certainly not a silver bullet. In the grand scheme of things, a payroll tax credit is no bullet at all, given that it fails to address a single structural problem of any kind and stand to benefit Wall Street more than Main Street.

We need to address the disease, not the symptoms.

What America Really Needs

Roubini says "America Need a Payroll Tax Cut".

I say what America needs most right now is an honest appraisal of the sorry economic mess we are in, politicians who will work in genuine bipartisan effort to tackle our numerous structural problems, and willpower from everyone to make short-term sacrifices for the long-term benefit of the country.

We need to start with a fresh look at numerous structural problems one-by-one and propose solutions to those problems one-by-one, starting with a breath of fresh air from the administration and Congress as to what those problem are!

After all, how can you fix something unless you admit what the problems are?

To date, all the Fed and Congress have done is bail out the banks and the bondholders (in other words the wealthy), at the expense of the middle class.

Given the problems are numerous and deep, the solutions will undoubtedly require a series of across the board sacrifices. Those sacrifices need to start with public unions, the gigantic military complex, government employees in general (Congress and state legislatures in particular), as well as anyone bailed out or benefiting from the numerous and massive fiscally unsound policies of the Fed and Congress.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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