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A corporate payroll tax cut won't work

June 15, 2011: 5:00 AM ET

Giving cash-rich companies a break on payroll taxes won't spur hiring. Try giving it back to the employees for longer instead.

FORTUNE -- Amid a slow economic recovery that's likely to move unnervingly slower, President Barack Obama's advisers have been knocking around a few ideas to improve America's grim job market. Talks reportedly include giving employers an incentive to hire more workers under a temporary cut in corporate payroll taxes.

Employees also pay the tax, which generates billions of dollars annually and contributes to Social Security and Medicare. However, beginning in January, they started paying modestly less after Congress reduced their share of the tax rate from 6.2% to 4.2% -- thinking that if workers see a bump in their paychecks with the tax break, they'll spend the extra cash and help the economy grow.

Certainly a break makes sense on the employee side. After all, wages have been stagnant for several years and measures to boost incomes could raise consumption, which makes up the biggest part (about 70%) of the U.S. economy. But so far, the tax cut has had limited effects. The bump in pay was only enough to offset higher prices, and hasn't translated much to more spending.

The question now is whether or not a tax cut at the corporate level would entice businesses to hire more.

Earlier this week, in a Financial Times editorial entitled, "How to avoid our own lost decade," former Obama economic adviser Larry Summers suggested that lowering labor costs for employers through a payroll tax break might just help the troubled jobs market: "Substantial withdrawal of fiscal support for demand at the end of 2011 would be premature," he writes. "Fiscal support should, in fact, be expanded by providing the payroll tax cut to employers as well as employees."

A business tax cut could appeal to Republican lawmakers who currently hold the House majority. But even if the idea might bode well politically, it makes little economic sense. Large, publicly traded U.S. companies today are not suffering from a cash problem. Far from it – they are sitting on nearly $2 trillion in cash and other liquid assets.

The vicious cycle continues: Companies aren't hiring because there's a lack of demand for their products and services, and that stems from high unemployment and economic uncertainty.

Roberton Williams, senior fellow at the Urban Institute's Tax Policy Center, says the focus should be efforts to stimulate consumer demand. Admittedly, the payroll tax cut for employees hasn't really translated into the extra spending that Congress had hoped for. While Summers says it might have helped the U.S. from slipping back into a recession, some economists have shown that the break has only been able to offset the rise in food and fuel prices.

Even so, a tax cut for workers would likely do more to spur hiring than a corporate tax break, says Moody's Analytics Chief Economist Mark Zandi. "Businesses don't respond very passionately to tax holidays because they know they're temporary," Zandi says, adding that extending the payroll tax cut for employees another year could increase consumption. It's a similar argument that's made against a temporary tax break on foreign income for multinational companies, an effort that's being lobbied by Apple (AAPL), Cisco (CSCO), and others.

It's true that even if workers take home more pay they might either save it or pay down their debt, which has generally been playing out following years of overspending before the financial crisis. But expanding the payroll tax cut – particularly for the poor – could increase consumption in a big way, says Williams, adding that lower-income households are more likely to spend their extra cash instead of saving it.

Indeed, U.S. corporations face several issues when it comes to hiring, from an unpredictable tax environment to uncertain health care costs for employees. And while reducing the payroll tax could spur more hiring for the few firms on the cusp of adding head count, a break for employers would only be glossing over the bigger problems consumers face.

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About This Author
Nin-Hai Tseng
Nin-Hai Tseng
Writer, Fortune

Nin-Hai Tseng covers economics and finance. Before joining Fortune, Tseng was a reporter at The Orlando Sentinel and a public affairs associate at GE. She holds an MPA from Columbia University and a BS in Journalism from the University of Florida. She lives in New York City.

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