Reducing Employers Payroll Taxes. Social Security,
which consists of Old-Age, Survivors, and Disability
Insurance, is financed by payroll taxes. Under current law,
both employers and employees pay 6.2 percent of an
employees annual earnings up to a ceiling that is adjusted
for wage growth and equals $106,800 in 2010. CBO
analyzed an option that would reduce employers payroll
taxes for 2010.
Firms would probably respond to this temporary reduction in their portion of the payroll tax through a combination of four channels. First, some firms would respond
to lower employment costs by reducing the prices they
charge in order to sell more goods or services. Those
higher sales would in turn spur production, which would
then increase hours worked and hiring. Second, some
firms would pass the tax savings on to employees in the
form of higher wages or other forms of compensation,
which in turn encourage more spending by those employees. However, wages tend to be inflexible in the short run
because of negotiation and administrative costs, so that
response is not likely to be very large. Third, some firms
would retain the tax savings as profits. Higher profits
would raise companies stock prices, and the resulting
higher household wealth would encourage more consumption, although shareholders are likely to spend only
a small portion of their gains. Higher profits would also
improve cash flow, enabling firms facing borrowing constraints to buy new equipment. Fourth, some firms
would use slightly more labor during a period when it
was temporarily less expensive. However, most of the
money forgone by the government would go to reduce
taxes for existing workers, soper dollar of forgone revenuethe added incentive to increase employment and
hours worked would be small. (For discussion of CBOs
modeling approach for the effects of reduced labor costs,
see Box 4 on page 14.)
