Colin Barr

Following the money in banking, economics, and Washington

Payroll tax holiday: hold the streamers

December 7, 2010: 12:59 PM ET

A partial payroll tax holiday should boost spending a bit, but it won't leave the economy in a partying mood.

The tax deal reached Monday by the White House and congressional Republicans would cut worker payroll tax contributions by about a third. The White House said the arrangement will put more money in workers' pockets at a time when there is considerable concern about weak demand for goods and services undermining a fragile recovery.

Dogged by weak demand

But while any measure that is apt to boost spending wins support nowadays – after all, Fed chief Ben Bernanke has been prodding political leaders to take actions that will both support the economy now and restore fiscal balance in coming years – some experts say the payroll tax cut isn't the perfect stimulus measure.

The Obama-Republican payroll tax holiday will cost $120 billion, which is "worth about twice as much" as the Making Work Pay tax credit will replace, says Roberton Williams of the Tax Policy Center.

But those goodies, like so much in the latest plan, are "skewed toward higher income," he adds.

That's bad, he says, because high earners are apt to save any added income, while those low on the wage scale tend to spend it out of necessity.

The payroll holiday will deliver windfalls of $4,000 or more for couples with income above $220,000, Roberton said, compared with the zilch they were receiving under the Making Work Pay program. The poor, meanwhile, will get less than they were receiving under Making Work Pay, he said.

A similar case against payroll tax holidays as a stimulus measure was outlined in a 2009 paper issued by the left-leaning Center for Budget Policies and Priorities.

Too little of the benefit would go to lower-income households, a group that would spend much of any tax cut it receives, while too much of the benefit would go to higher-income taxpayers, a group likely to save much of its tax cut. A worker earning $100,000 would receive ten times as big a tax cut as one earning $10,000.

One way to deal with that would be to set a cap on the income level at which the payroll tax holiday applies; another, aiming at more stimulus, would give workers a holiday on their entire payroll tax contribution. But the latter move would triple the cost of the maneuver.

Besides, such approaches wouldn't play well with Republicans, whose tax-cutting priorities lie elsewhere.

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About This Author
Colin Barr
Colin Barr
Senior Writer, Fortune

Colin Barr has covered finance for Fortune.com since November 2007. Previously he was a writer and editor for TheStreet.com, winning a 2006 Society of American Business Editors and Writers award for "The Five Dumbest Things on Wall Street," and for Dow Jones Newswires. He is a 1991 graduate of Penn State and lives in Port Washington, N.Y., with his wife Meena Bose and their two kids.

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