JP Morgan Warns Payroll Tax Cut Expiration Could Hammer 2013 Growth

As I wrote earlier this week, for all the talk of higher income taxes allegedly hurting small business hiring in the presidential campaign there’s basically no reason to think this will happen. At the same time, that’s not to say we shouldn’t worry about tax issues and employment growth in 2013. The real issue is the looming expiration of the payroll tax cuts that were enacted in the 2010 lame duck session. This is the part of the “fiscal cliff” that neither party seems very interested in, but it has the biggest short-term macroeconomic impact.

A research note released by JP Morgan this week (PDF) estimates that economic growth will be 0.6 percentage points slower in 2013 than it would be if the payroll tax cuts were extended. That’s a big deal. In fact, they anticipate it being by far the largest drag on growth associated with the fiscal cliff.

Recall that the payroll tax hike is a double-whammy. On the demand side, it means that every American who works for a living will have a bit less money in our pockets and thus less to spend on goods and service. But then on the supply side, higher taxes on wage earners mean it’ll be more expensive for businesses to hire people to do work for them. Note that payroll tax cuts combined with the Federal Reserve’s low interest rate policies are, in practice, the closest we get to the idea of a hypothetical “helicopter drop” of money. In ordinary times, vastly increased government borrowing to cover a broad-based tax cut would tend to raise interest rates and crowd out private sector investment. But with the economy in a depressed state, the Fed can hold those interest rates low without sparking inflation. It’s more or less a free lunch, but neither Democrats nor Republicans seem appropriately interested in eating it.