Payroll Tax Cut Deal Would Bolster Economy

Not passing it, says one analyst, would mean a 1 percent hit to economic growth

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Congress has finally agreed upon a jobs bill.

This week, Congress members reached a $150 billion bipartisan agreement to extend the two percentage-point payroll tax cut first enacted in late 2010, and will also once again extend unemployment benefits. While not packaged as a jobs act, the package could be a boon to both employment and economic growth in the U.S.

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"Extending the payroll tax cut holiday is critical," says Ryan Sweet, senior economist with Moody's Analytics, a division of Moody's that performs economic research. He cites Europe's contracting economy, rising gas prices, and diminished savings as evidence that allowing Americans to keep even a little extra spending money could bolster the U.S. economy. For a family making $50,000 per year, the payroll tax cut will mean around $40 extra per paycheck. That extra money, says Sweet, can provide a "cushion" against spikes in energy prices or other shocks that could threaten the current recovery.

"It's going to put roughly $100 billion into workers' pockets, and that can have a meaningful impact on the economy via consumer spending," says Sweet. "All in all, the payroll tax holiday and unemployment insurance benefits combined, it's about 1 percent of GDP."

According to an August 2011 report from Moody's Analytics, every $1 in payroll tax cuts adds $1.27 to the GDP. The boost from unemployment benefits is even more intense, boosting output by $1.55 for every dollar of government outlays.

"Unemployment insurance has bigger bang for the buck [than the payroll tax cut]," says Chad Stone, chief economist for the Center on Budget and Policy Priorities, a left-leaning D.C.-based think tank. "Low-income folks are likely to be as constrained as unemployed workers...but others are likely to save some [of their payroll tax cut]," whereas unemployment benefits get spent more fully and more quickly, says Stone.

The biggest obstacle to passing the deal came from congressional Republicans, who had insisted that the tax cut extension be paid for with spending cuts. Republicans dropped that demand this week, but both parties have agreed that the $50 billion cost of jobless benefits and the so-called doc fix will be offset.

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While the deal might boost growth, Republicans' desire for fiscal restraint is not unfounded. A recent report from the Congressional Budget Office showed that, while continuous substantial increases in federal spending can create short-term boosts, such a policy can also make for slower growth in the long run, along with mounting deficits and debt.

"Lawmakers need to create a credible long-term plan for improving our fiscal situation," says Sweet, but trying to cut deficits as quickly as possible could harm the economy. "Even with extending payroll tax holiday and unemployment insurance benefits, fiscal policy is going to be a substantial drag on U.S. GDP this year, on the U.S. economy, and in 2013."