Economix Blog: Casey B. Mulligan: The Logic of Cutting Payroll Taxes

Casey B. Mulligan is an economics professor at the University of Chicago.

Payroll taxes are by no means the only thing that stops people from working, but one of President Obama’s payroll tax cut proposals could nonetheless create a million or more jobs.

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Last week I estimated that the president’s proposal to cut the employer portion of the payroll tax by 3.1 percentage points could raise employment by more than a million, and maybe as much as three million.

You might (as some readers wrote to me) think that a payroll tax cut is not, by itself, a good reason for employers to hire, and on that basis conclude that my estimate is way off.

I agree that jobs are not created by payroll tax cuts alone, and my estimate reflects that fact. About 131 million adults are working now, and 109 million adults are not working. If I’m right that the payroll tax cut would raise employment by one million to three million, that means that 106 million to 108 million adults would still not be working despite the payroll tax cut.

The chart below illustrates the results for the case that the payroll tax cut raises employment by exactly two million.

In other words, my estimate is that at least 97 percent of people not working would still not be working regardless of the payroll tax cut. That’s because, as you might deduce, payroll taxes are only one factor among many that determine how many people are employed. Nevertheless, raising employment by one million to three million would be an accomplishment for the president, and one that would be visible in the national statistics.

By the same logic, if someone were to propose raising the payroll tax by 3.1 percentage points, I would expect employment to be reduced by one million to three million. Again, the payroll tax is only one of many factors affecting hiring decisions, which is why my estimate of a payroll tax increase implies that more than 97 percent of workers would continue to work despite the increase.

Indeed, we all know people who would continue to work even if the payroll tax were raised by 30 percentage points, let alone three. We also know people who would not work even if taxes were eliminated completely.

But the fact that more than 100 million people are not employed, and more than 100 million people are employed, suggests that there could well be a million people (or two million, or three million) who are near the fence. For that small fraction of the population, there are almost as many things pushing toward making them employed as making them unemployed; a payroll tax cut could tip the balance.

For hundreds of millions of others, the balance is tilted too far for a payroll tax cut to make a difference. But while economists can debate the exact numbers, few of us can conclude that a small tax cut has no effect. Rather, a small tax cut should be expected to have a small effect — and at this point one worth seeking.

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