Payroll Tax Cut
Labor cost as a share of business output is now at a post WW – II low. and has fallen about eight percentage points since 2000. This would suggest that the weak demand for labor does not stem from high labor cost. Actually since the third quarter of 2000 while labor cost as a share of total business cost has plunged, private payroll employment has also fallen from 111.2 million to 107.6 million in the second quarter of 2010. Yes, this data contradicts the theory taught in introductory economics.
But, if as this data series implies that weak employment is not because of high labor cost why should further cuts in labor cost via a cut in the payroll tax lead firms to hire more employees? I strongly suspect that those advocating cutting the payroll tax simply remember the theory they learned in their introductory economics class and have never actually looked at the data. If they had they would know that changes in the demand for labor and changes in labor compensation have a strong positive correlation. Of course this directly contradicts the theory they learned in introductory economics that labor demand is a downward sloping function of labor compensation. But remember, that theory is simply a massive over-simplification used to explain basic economic concepts to some teenagers. The theory assumes that all other things are constant and in reality that never really happens. In reality, the demand for labor is a function of many things of which labor compensation is only one factor and generally a relatively minor factor at that. In the real world the demand curve for labor is not a downward sloping function of compensation. Remember, when Alfred Marshall the great economist who did more to develop graphical analysis than anyone else was asked why he developed this approach his answer was,”so the gentlemen in the back row can understand what I’m talking about”.
Labor demand is a derived demand. Firms hire labor because they think they can profitably sell the goods and/or services the labor produces not because they derive some utility from hiring labor. Consequently, the dominant factor in the demand for labor is the firms perception of the demand for that firms output. Even if the cost of labor falls, firms still will not hire more labor to produce more output if the firms does not expect to sell the expanded output. Consequently, those claiming that cutting labor cost will induce firms to hire more labor are just spouting some ideological fantasy that has no basis in reality or even in advanced economic theory.
So what drives the demand for labor. If I want to forecast employment I make it a simple estimate of GDP less productivity. In this estimate labor cost does not play a enter the equation at all. In my experience labor costs is only important in the labor supply equation where higher labor payments induce individuals to enter the labor force.
In response to questions in the comments that if labor’s share fell, what rose, I’ve added this chart.
PS. The last time I published this chart it was of an index number that was derived by dividing one index number by another. So anyone could download the data from the BLS and reproduce it. But this chart is of the actual raw data that shows labor cost as an actual share of business output. BLS does not publish this raw data. Haver Analytics made special arrangements to get the raw data from the BLS so they could generate this data series. Consequently you will not be able to reproduce this data series from publicly available data.
That’s one ugly graph you made Spencer. Where is Samuel Gompers when you need him?
But, but, but…my intro course pretty much always expressed demand and supply functions as something like this –
D(L) = f(W, D(Y), K,…)
Demand for labor is a function of wages, demand for output, capital and a bunch of other stuff the lecturer didn’t bother to specify. My problem with arguments about demand for labor being purely – or even mostly – a function of labor costs is that it’s more simple-minded that what was taught in intro.
Well done spencer.
So we are clearly seeing a dramatic decline in labor as a percentage of business costs. The question I have is what is repacing those costs? Is it profits?
The chart almost demands a second inquiry.
of course even if “payroll taxes” did drive down the demand for labor, you still need to pay people enough to live on. and living does imply making enough money to be able to retire one day or pay medical expenses.
unless you subscribe to a theory that labor should be paid just enough for food for the day, and maybe not even that.
the payroll “tax” is just a way of “deferring wages” for a specific, predicatble, purpose in the safest way possible.
“economists” who one day say “the employer’s share” is “really” the employee’s money, and the next day say “the payroll tax is a jobs killer” are whores. and the people who repeat what they say are fools.
Yes, nice to see again, as Yves would note that simplistic application of simplistic econ theory results in erroneous pulbic policy. But hey, life is simple has been the message from both parties and thus the Tea Party.
However, regarding tax cuts of any kind as the cure all to lack of demand can simply be countered as being wrong by noting that you me and Louise do not earn income via tax cuts.
And, noting that the proposal is only “temporary” is crap. The current tax cuts are only “temporary” and you see where that is going. Or how about reversing the argument about being on the government dole? You wouldn’t what labor to be relying on the government for it’s earnings now would you?
At the same time, companies are hiring. They just are not doing it here.
Face it. To fix what is wrong requires undoing all that lead to NAFTA, CAFTA and financialization. That ain’t happening anytime soon. So we’re going to keep getting gimic fixes, that is until as Colbert notes: if we don’t help the poor they are going to rise up against us! Keep fear alive!
K Harris you are absolutely right about what is taught in a “good” school.
But on the other hand if you go to right wing and/or libertarian web sites the other things are completely omitted. They all start out with the assumption that the labor demand curve is a downward sloping function of the price of labor. I really have my doubts that the introductory course at GMU teaches it any other way.
Megan McArdle is very proud of her Chicago education and absolutely refuses to accept that anything else enters into the demand for labor. This assumption or over simplified analysis is behind the policy prescriptions of many, many academic economists.
Yes, the other side of the chart is that falling labor costs have been reflected in higher profits. Profits as a share of GDP have been on an upward slope since the early 1980s.
“But, if as this data series implies that weak employment is not because of high labor cost why should further cuts in labor cost via a cut in the payroll tax lead firms to hire more employees?”
I do not think that that is the main argument for a payroll tax cut or holiday. Rather, I think that it is that, given the lack of foresight in last year’s stimulus legislation, we need continuing stimulus now, and we need it to be focused on people with lower incomes. Additional jobs programs are called for, but they take time to get going. For immediate stimulus we need to cut taxes, and the main tax that lower income people pay is the payroll tax. Any immediate effect that a payroll tax cut would have on hiring — as opposed to hiring in response to increased demand — would be a bonus.
This was my understanding of the payroll tax holiday. It was more of a demand stimulus. I have no idea whether it’s a good idea or not. I suspect that time will not stop for us, and Social Security recipients who retire in the next two years, or however long the tax holiday lasts, will want to receive their checks. I may be wrong about that.
To the extent that a tax cut for lower and middle-wage workers would spur demand, we then address hiring demand as spencer suggests, through orders.
perhaps the extra few bucks… is it going to the workers or to the employers?… would “stimulate demand.” or perhaps even the working poor would look out at the economy and put the money in the bank “in case.”
but if the money is not to be looted from Social Security (the workers’ retirement savings) it will have to come from “the budget” through higher general taxes or more borrowing. In that case why involve Social Security at all? Just give the folks an “income tax holiday” and if the poor don’t pay an income tax, give their bosses an income tax holiday as an offset to giving their workers a “recession bonus.”
actually it is a completely brain damaged idea. it has nothing to do with “stimulus’ or “jobs creation.” it is just another cute idea from the Petersons to weaken support for Social Security. What is truly sickening is that “liberal economists” fall for it.
As wages, share of income/productivity, keeps declining. What tax do we cut out next? Some schools are requiring toilet paper as the list of items a child needs to supply for themself. How much further down this hole do we fall thinking that flapping our arms will save us?
Crapping on reasonable ideas because you have set your mind against them isn’t really legitimate. Giving households more money to spend is exactly “stimulus” of the very kind that we need now. There may be political ramifications to cutting FICA. Those can be discussed. Meanwhile, we will go on discussing the merits of a FICA tax holiday, without regard to any stomach condition you may suffer as a result. Your emotional response to others’ ideas does not make your analysis any righter.
Bill White: “Social Security recipients who retire in the next two years, or however long the tax holiday lasts, will want to receive their checks.”
IIUC, Social Security benefits do not depend upon how much money you have paid in taxes. A tax holiday would not change that, per se. And the gov’t is required to pay its obligations by the Constitution. Besides, it will be able to do so. 🙂
Fine, cut the tax, give a break, make it “temporary”. But, once there, be ready to counter the aruguments that will come when it’s time to return the tax.
I hear no proposals to improve the share of income/productivity to those who would get the tax holiday. None. Without such a plan, everything proposed is just delaying the inevitable: deflation. Only, it will be a deflation that harms those who don’t have the dollars. Those with the dollars will play the world arbitrage game.
I agree this is a major risk in the argument to cut SS/MC to balance the budget by proposing the payroll tax as a vehicle to promote stimulus. I’m not willing to take that risk. Not with this Democratic party.
We got out of the Depression because of a parallel tracks of 1. government stimulation plus 2. reduction in economic power of the plutrocracy. The second track is not even in the imagination of the political class.
Tax cuts are dishonestly being presented as a solution. And the people will get them because in the end the mantra “taxes are bad”, taxes are the cause of your lack of income will win.
Further down the hole we go.
Why is it a surprise to anyone that Spencer has been able to graphically display/demonstrate that the wages share of production costs have been falling? And why would anyone have to ask where the value of that lower share of cost has been showing up? Has it not been demonstrated repeatedly, to the point of common knowledge, that there is an ever increasing disparity in the distribution of income over the past three decades or more?
And how does that change in income and wealth (which tends to be a function of income, no?) bear any relationship to the bocus plan to cut FICA contributions? I guess that there is some basis for such a relationship. Now that the wealthiest Americans have all the production income save a scrap for the peons, they would like a greater share of all the retirement funds that our economy can generate. Screw the workers while they can work and then screw them again when they’re too old to do so and might need to relax a wee bit in retirement. Our society is fast becoming a sorry example of progressive ideology as measured by man’s humanity for man.
Every employer I ever worked for added “payroll taxes” to the employee cost per head, along with any other bennies like health insurance. Even had a wise guy boss once that would quote the entire figure during review time.
yes. and as i pointed out at the time that “most economists agree” that its “really” the employees money, the bosses regard it ALL, both the employees share and the boss’s share as “really the boss’s money. after all it’s his name on the check.” there is no “real” way to say one way or the other. it’s the employees money because he gets it in the end. it is no doubt a jobs killer because any money you have to pay labor is a jobs killer. why i remember back in the dear old south when we didn’t have to worry about wages and other intolerable costs on business.
Min, your social security check is calculated on the basis of how much you paid in taxes.
I’ve assumed what they mean by cutting “payoll taxes”‘ is just the employer paid half of SS. I’m assuming the FICA deduction on the employees’ pay stub remains. The idea is to “give” money to companies (6.2%), so they will run out and hire a bunch of people. Poor people stimulating the economy doesn’t enter into the plan. Keynes is wrong again!
So if anyone sees what they like about that, it escapes me.
the only one here with a stomach condition is yours. plenty of arguments have been advanced that it won’t work as a stimulus. and if you wanted that kind of a “stimulus” why not just cut wages by fiat so the bosses have more incentive to hire. or give the employees an extra check courtesy of the government.
the only reason to drag the payroll tax into the argument is to serve as a trojan horse to kill off Social Security.
so no one is crapping on a reasonable idea. reasonable people are trying to explain to you the reasons for rejecting a crappy idea.
And temporary, my ass.
“Those with the dollars will play the world arbitrage game. “
That’s my plan, but it’s harder than it sounds. Plus I don’t have a whole lot of capacity for errors.
The proposal currently is on the employERS side of the event, you are correct, not the employees.
If you listen to the experts, Brazil is the Best Place on Earth right now. Can you imagine the entire liquid personal net worth of the US, Europe and Japan piling into Brazil?
I am not sure many even understand what they are saying Jack, with the numbers and appropriate caveats. And the mentality issue has plenty of example on the game of power and resources. ‘Lesser people’ is a real belief, and “money” is a cosmic moral point system to some.
“labor compensation is only one factor and generally a relatively minor factor at that.”
i am trying to imagine a world in which “the high cost of labor drives down employment, or drives up unemployment.
lot of high priced workers sitting around unemployed because no one can afford to hire them?
this is so close to the (real) paul samuelson view of the NAIRU that it makes me wonder if economists have ever had to look for a job. or live in a world in which “causality” has a direction.
How do we even come to use the term “high priced” labor in an economy wherein half the working force earns less than $50,000 per year and is fast losing any semblance of a retirement income. Yet the executive class is goiong home with incomes of hundreds of thousands of dollars at the low end and bountiful fringe pkgs that will keep them well financed throughout their lives. The very idea of high priced labor is a fiction foisted upon us by those same people who know too well the value of their own high priced pay packages.
spencer – “Consequently, the dominant factor in the demand for labor is the firms perception of the demand for that firms output. Even if the cost of labor falls, firms still will not hire more labor to produce more output if the firms does not expect to sell the expanded output. Consequently, those claiming that cutting labor cost will induce firms to hire more labor are just spouting some ideological fantasy that has no basis in reality or even in advanced economic theory.”
That is probably correct.
I would like to see the business surveys that show support for the two-year payroll tax holiday, including the projected number or percentage of new hires resulting from such legislation.
Put the Pricetag on the Payroll Holiday Proposal
It’s good to see Angry Bear discussing the proposed two-year payroll tax holiday.
When is a main poster going to deal with the issue of cost for the proposal?
Thus far, it appears that those proposing this legislation are getting a free pass on the proposal cost. Some, including Roubini, have stated that elimination or termination of the upper income tax relief provisions made available during the Bush II era will cover the costs of the payroll tax holiday. The news media reporters at CNBC, MSNBC, and CNN discussed this issue yesterday, and said the cost would be covered by elimination of the upper income tax provisions. That is pure nonsense if the payroll tax holiday applies to all workers.
Where’s the math?
I expect that some readers will be very surprised at how much lost Federal revenue is involved.
I can’t find where I read it anymore, but the Obama Admin did survey biz (larger, I imagine) and ask if a payroll tax holiday would cause hiring. They said no.
So there is no theoretical or real world evidence it would accomplish that goal.
Labor demand is a derived demand. Firms hire labor because they think they can profitably sell the goods and/or services the labor produces not because they derive some utility from hiring labor. Consequently, the dominant factor in the demand for labor is the firms perception of the demand for that firms output.
And the ultimate source of demand is the income of labor, and when that is squezed, so is demand, thus the bottom line of the same firms which cut back on their labor costs. So since their bottom line is being squeezed, they fire and don’t hire, further cutting back on labor income. So we have a death spiral… But, what about the purveyors of luxury goods? They don’t require demand from labor. We should expect them to prosper, at least for a while. They and the Walmarts, and other sellers of inferior goods, while the Sears and the Pennys and their suppliers go belly up, while society is torn in two.
You said SS comes out of taxes.
Is this really you?!?!
coberly, isn’t it calculated on eligible income over a number of years? (OC, without a tax holiday, that is equivalent to a calculation on how much you paid. :)) If not, then a tax holiday law would need to address that.
I do not know what you consider current, but a payroll tax holiday was proposed at least two years ago: http://moslereconomics.com/2008/09/29/time-for-a-payroll-tax-holiday/
Note that it would not be on the employer’s side only. That idea is ridiculous.
when in Rome, speak Latin.
I think you are right… (note to MG. that doesn’t mean i don’t know the answer, it means i am not sure I understand min) but the difference is insignificant. your “eligible earnings” vary with the taxes you paid, so you can address your formula to the taxes or the earnings. same difference. what they plan to do by giving a “holiday” about matching the benefits to the taxes is beyond me. either they are going to make up the payroll taxes with income taxes, or they are planning to cut benefits so it doesn’t matter.
yes, the calculation is based on the 35 “best” years…. but that is so close to a direct functioin of taxes paid that it just amounts to a simpler way for the folks to calculate their own benefit…and no reason the SSA shouldn’t use the same formula. Benefits are still directly tied to the taxes you paid.
without doing the math I think you are right about this. the whole idea is nonsense. the only reason we are hearing about it is because it gets people toward the point where they say “If it wasn’t for that darn payroll tax…”
coberly: “why i remember back in the dear old south when we didn’t have to worry about wages and other intolerable costs on business.”
Los Esclavos Felices! 🙂
Not to worry. Debt peonage is even better. You don’t have to pay for the peons’ food, shelter, or health care. After all, the market will allocate those things efficiently and correctly. 🙂
coberly: “what they plan to do by giving a “holiday” about matching the benefits to the taxes is beyond me. either they are going to make up the payroll taxes with income taxes, or they are planning to cut benefits so it doesn’t matter.”
That depends on who the “they” are, I guess. I am sure that Mosler does not intend to reduce benefits. 🙂
coberly: “ In that case why involve Social Security at all? Just give the folks an “income tax holiday” and if the poor don’t pay an income tax, give their bosses an income tax holiday as an offset to giving their workers a “recession bonus.”
IMO, one major problem with the stimulus so far is that it has been targeted at creditors and bosses, who, in the absence of aggregate demand, have not either lent or spent much money. That sort of defeats the purpose, doesn’t it? Better to target it at debtors and workers, who will spend money or reduce their debt burden.
There are company towns, but they’re not free of course.
i agree. my comment was addressed to those who want a tax cut stimulus.
if you read what i said more carefully, it was “instead of cutting the payroll tax only to have to replace the money from the income tax, why not cut the income tax without pretending you are cutting the payroll tax. and then i said… if you are worried that the poor don’t pay income tax so cutting income tax won’t put any money in their pocket, just cut the income tax of the employers in return for their giving a ‘bonus” to the workers. but i have also said again and again on this blog that i don’t think any tax cut, or any money given out to person is going to stimulate a damn thing as long as people are afraid to spend. if you need a stimulus you are going to have to create jobs. government jobs if that’s what it takes.