Tuesday, March 10, 2009

The Behavioral Case for a Payroll Tax Holiday

Conventional wisdom is settling on the idea that the Obama "stimulus" was too small. This is probably true, but hard to judge since none of it has gone into effect yet. It is clear that the "stimulus" was too slow and also did nothing for households, who continue to delever, rendering it, unstimulative. A true stimulus, which I do not expect to see, is a payroll tax holiday. Here's a behavioral explanation for why this works:
A more compelling explanation for why rebates haven’t worked very well is that they have been handed out as lump sums. You might think that handing people a big chunk of change is a perfect way to get them to spend it. But it isn’t, because people don’t treat all windfalls as found money. Instead, in the words of the behavioral economist Richard Thaler, people put different windfalls in different “mental accounts,” which in turn influences what they do with the money
A tax holiday would instantly increase incomes for households, and instantly make employees cheaper for businesses. A simple, effective way to restore aggregate demand.

The other thing which is sort of working in the US, but may be doing all the heavy lifting in Germany, are automatic stabilizers:
The German system has stimulus measures built in that have not to be passed by government once a recession is there.

There is a comfortable unemployment insurance and social security fund that Americans can only dream of. There is a thing called Kurzarbeit that enables companies to reduce on duty hours for their workforce in difficult times and receive a subsidy from the employment agency to make up for the reduced wages for their employees. Thus in contrast to most other countries they can keep their work force but at the same time cut cost.
Automatic stabilizers increase the deficit during a fall in employment due to reduced aggregate demand, helping to replace that loss. They can also support a higher level of general unemployment, though.

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