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Far Better Ways Than Payroll Tax Cut to Contain Virus’s Economic Damage

March 10, 2020 at 5:30 PM

The threat of a COVID-19 pandemic demands not only an aggressive public health response to contain and treat the virus’s health impacts, but also an aggressive fiscal policy response to try to avert a major recession, which is now a distinct possibility. The Trump Administration has suggested trying to shore up the economy through a payroll tax cut, but direct, immediate stimulus payments — like those made with bipartisan support when recession threatened in 2008 — would do far more to reduce immediate hardship and buttress an economy that faces serious risk. Such measures — along with strengthening Medicaid coverage, unemployment insurance, nutrition assistance, and paid sick leave — would deliver assistance quickly to people struggling to get by, who will spend virtually all of the additional resources they receive and thereby help keep consumer purchases from declining too sharply and sending the economy downhill.

A COVID-19 pandemic could trigger a damaging recession by disrupting both supply chains and workplaces, thereby limiting companies’ ability to supply or sell goods and services; those disruptions, in turn, would cause growing declines in the purchase of goods and services, generating widespread layoffs and possibly widespread business failures. In addition, workers who lose earnings because they are sick, quarantined, caring for family members, or laid off (or have their hours reduced) will have less income to spend on goods and services, which will further slow the economy and lead to additional layoffs. Fiscal stimulus to shore up demand for goods and services thus is essential. It will be most effective if it is delivered rapidly to those who will quickly spend virtually all additional resources they receive — that is, low- and middle-income households, who spend most of the income they have.

A payroll tax cut scores poorly on these fronts: it would be too slow, not well targeted, and too narrow. Consider, for example, a payroll tax cut of 2 percent of workers’ earnings:

  • A single parent getting by on $25,000 a year would receive just $500 over the course of a year, even as a couple with a combined $275,400 income (with each spouse earning half this amount) got $5,500. Even if the tax cut’s dollar value were capped, only higher earners would get the maximum benefit. That’s not sound economic policy, since affluent households generally spend a much smaller share of any added income than lower-income households do.
  • Workers would receive the benefit a little bit at a time in each paycheck, meaning it would not be delivered quickly enough to provide the desired boost to the economy. For example, a payroll tax cut would have to last more than 40 months to give a full-time worker earning the federal minimum wage of $7.25 an hour a $1,000 tax cut. That same amount could be delivered much more quickly in a stimulus payment check.
  • People without earnings wouldn’t benefit at all, though they are among those likeliest to spend any added resources they receive. This group includes people who have been laid off from work or can’t work because they are caring for family members, as well as seniors and people with disabilities. People supporting children and other dependents wouldn’t receive any added help.

The Trump Administration has also suggested targeted tax deferrals for certain industries such as airlines. Such responses have limited effectiveness — especially if the hit to demand is large and sustained — as tax deferrals are valuable only if companies continue making taxable profits, which becomes less likely as demand slows. Moreover, there’s no guarantee that businesses would use that tax relief to protect their workers economically; with less demand for air travel, hotel rooms, and the like, firms could take the tax deferrals and still lay off workers. And, if they laid off workers or cut their hours, their workers would consume less, which would hurt other industries and further slow the economy.

Sending stimulus checks to most Americans would put more money in households’ hands much more quickly than a payroll tax cut of the same cost. Also, stimulus checks can be sent both to workers and to people without earnings, including people receiving Social Security, Supplemental Security Income, or VA benefits and people unable to find jobs.

Other Measures Also Critical

Such assistance to households, while important, should be only part of the response. Policymakers also need to strengthen unemployment insurance (UI), including disaster UI for workers laid off in areas heavily affected by the virus who wouldn’t otherwise receive UI; expand nutrition assistance; and extend paid sick leave, among other steps. Such economic security programs would both help people weather a public health and economic crisis and bolster the economy by cushioning the decline in consumer demand.

Also crucial is an increase in federal financial support to state Medicaid programs. State budgets will likely face a double blow from COVID-19: 1) costs directly associated with responding to the virus, including higher state Medicaid costs; and 2) lower state tax revenues alongside an increased need for Medicaid and other state services due to the slower economy and higher unemployment. Temporarily raising the federal share of state Medicaid costs, as federal policymakers did in the last two recessions, is essential to prevent states from restricting coverage precisely when it would be most damaging to public health and the economy. Other measures to expand access to health coverage and cover COVID-19-related costs for those who remain uninsured will likely be needed as well.

The steps above are, of course, in addition to the actions needed to support the direct public health response to the virus and strengthen health system capacity. But the steps outlined here are vital as well, because avoiding a long, severe recession is critical: prolonged unemployment harms not only the health and well-being of workers and their families, but also workers’ future job prospects and lifetime earnings. Workers without a college degree and workers of color are the most vulnerable to these adverse effects. And recessions can erode job skills among unemployed workers and reduce business investment in ways that depress the economy’s productive capacity long past the end of the recession.

We will discuss these and other issues in forthcoming CBPP analyses and blog posts in the weeks ahead.

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