Tuesday, March 3, 2009

Does Economist.com Understand Incidence of the Payroll Tax?

Backdoor Payroll Tax Cut lays out a silly argument:

One participant, who writes about technology, remarked that it is not unusual for tech firms to fire their employees and rehire them the next week as consultants. This is essentially a backdoor payroll tax reduction for the employer. When a worker is considered a contracter they become responsible for their full tax burden to Social Security and Medicare (and the cost of health and pension benefits).

So the total taxes paid to the government do not fall – just who ends up directly paying the government. Not to praise anything from the Heritage Foundation, but even Stephen Entin can explain the standard view with respect to who bears the incidence of the payroll tax:

The relatively elastic demand for labor, coupled with the assumption of a highly inelastic supply of labor, means that labor bears most of the initial economic incidence of taxes on labor income. It has become common to assert that all taxes on labor income fall on the worker, including the employers’ share of the pay¬roll tax, the employees’ share of the payroll tax, the unemployment compensation tax, and the portion of the income tax that falls on wages and salaries.

As the primary burden on the employer for paying this tax has been shifted to the worker, the standard model says that the wage rate being paid by the employer to the worker rises in an exactly offsetting fashion.


BillCinSD said...

But when this happens, does the wage rate being paid by the employer to the worker rises in an exactly offsetting fashion? This ought to be relatively easy to study, so what does the data say?

Unverified models are about as smelly as unflushed feces

Sandwichman said...

Never trust a standard model until you've seen the empirical tests and understand the theoretical argument. Too often "standard models" are convenient fictions that eliminate bothersome uncertainties. Logically, I would suspect that the payroll tax incidence is highly uncertain and depends on the relative bargaining position of the particular employer and employees.

I did see a review of empirical studies many years ago that concluded the results were inconclusive. That conclusion was glossed over in the executive summary and substituted with a recital of the standard model. The exec. summ. version then was cited in another paper I read as verification of the standard model. This was 12 years ago, so I don't know if I can still dig up the citation.

TheTrucker said...

The big gains for the employer are the offloading of health insurance and any form of retirement contributions as well as the FUTA and FICA. If the contractor that was an employee forms a sub-s corp, then the contractor can pay himself $100 a month in salary and take the rest of the income as profit distributions thus escaping the FICA tax on those distributions. The younger tech people often get group insurance through various technical organizations such as IEEE.

All of this bean counting and farting around could be eliminated by funding SS and Medicare for all with carbon taxes -- a very straight forward tax and rebate system, indeed.

Free Exchange said...

Some pushback: