"If you cut a tax on employers, this reduces labor costs, increases the quantity of labor demanded, and reduces surplus labor. If you cut a tax on employees, in contrast, this increases worker compensation, increases the quantity of labor supplied, and increases surplus labor.
In both cases, admittedly, a tax cut might directly increase demand and, with nominal wage rigidity, increase employment. But when you cut taxes on employers, the incentive effect and the fiscal effect work in the same direction. When you cut taxes on employees, the incentive effect and the fiscal effect work in opposite directions.
That's why Obama's proposed payroll tax holiday botches an idea of truly Singaporean cleverness. Instead of giving the tax cut to employers, where it would do the maximum good, or splitting it evenly, where it would do intermediate good, he's giving all of it to employees, where it does the minimum good"
I have an alternative interpretation. It is true that if you cut a tax on employees, you do very little to directly correct the labor market imbalances. However, the poor functioning of the labor market was caused by the insufficiently stimulative monetary policy that is constrained by the zero bound on interest rates. The zero interest rate bound creates the most damage to those economic agents who have the weakest balance sheets. And these days the household balance sheets are the weakest. Weak household balance sheets are pushing the optimal fed funds rate down to the negative levels. If you cut a tax on employees, you relax the credit constraints on household balance sheets, and the day when the zero interest rate bound is no longer constraining Bernanke will arrive sooner.
In late 2008 - early 2009 balance sheets of non-financial corporations were very weak, so Bryan Caplan's logic would have worked then very well. But today Obama's payroll tax holiday is the solution that will have the most powerful effect.
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