Unit 4 Macro: Employment Taxes and Unemployment

Are reductions in employment taxes an effective and equitable strategy for making in-roads into the high unemployment rates across many of the world’s leading economies? The debate has been highlighted by proposals from President Obama to make cutting payroll taxes a key element of his emergency stimulus programme for a US economy teetering on the edge of another recession.

In Britain the economy is undoubtedly fragile with real disposable incomes falling and consumer & business confidence weakening month by month. Creating new jobs is key to making the recovery durable and country’s leading employer organisation, the CBI has led the way in lobbying for a reduction in the national insurance contributions paid by employers. In particular they want a tax cut for businesses that hire the young unemployed - with jobless rates among 18-24 year-olds now above 20%.

In the United States, President Obama is seeking an extra $65 billion as part of a huge stimulus package to encourage small businesses to hire more workers. This includes halving employer payroll taxes to 3.1 percent for the first $5 million of a company’s wage bill in 2012.

Both measures would reduce the financial cost of hiring extra workers and should, in theory, bring about an expansion in the aggregate demand for labour. This in turn might create a positive multiplier effect as the newly employed start to spend their extra incomes on goods and services.

Key to the debate is whether these targeted tax cuts will have much impact on the hiring rates of businesses large and small across the economy. The most pressing problems facing businesses have remain unaltered since the start of the downturn in 2008-09, namely weak levels of domestic and overseas demand allied to difficulties in raising new finance for expansion from a banking system riddled with bad debts and still looking to de-leverage (cut their loan books).

Lowering the employer-cost of hiring extra workers is in principle a straight-forward stimulus policy, but the impact might also be curbed by persistent skills shortages among those looking for work. And a recent report from Oxfam found that nearly two-thirds of parents cannot afford not to work but at the same time are struggling to pay for childcare and are less likely to accept work if it becomes available.

As always when discussing stimulus policies, one can ask the question, is the money devoted to tax breaks on firms who hire more workers better spent elsewhere? Perhaps in measures designed to boost innovation or in income tax cuts for lower-income families?