21 Feb 2010

Making Work Pay Tax Credit

I paid my taxes this morning and realized that I owe $146. Past years have been more painful but this year, what hurt more is my expectation that I had a refund coming. Apparently, the Making Work Pay tax credit lowered withholding levels, but did not change tax rates. The $400 credit therefore makes the lowered withholding amount coincide with the unchanging tax rates. I have two problems with the credit:
  • I did not realize my checks were larger. I get direct deposit, and do not pay attention to small changes in the amounts, especially because they frequently change for other reasons. Therefore, this had no stimulative effect on me.
  • The overall tax rate didn't change - the credit is merely temporary, and it is very nice, but why not permanently lower the rates? See Permanent Income Hypothesis.
Bottom Line: May we have one federal tax which includes both the income and payroll (social security and medicare) taxes, including the share that our employers pay on behalf of us?


  1. Hear, hear. Payroll taxes are built on a bad, regressive tax structure.

  2. 1)Permanent Income Hypothesis relies on you being aware what your income is. So 1 makes 2 not valid.

    2) MWPTC does lower average rates, but not marginal rates. It's like the EITC, it's a way to reduce inequality, cut taxes, and encourage work. Overall the payroll tax system is similar to a Friedmanite negative income tax, except that it's a tax on labor, and more regressive than a flat tax, as the Social Security contributions end around 100000 in income.

    3) Temporary tax cuts are a reasonable part of stimulus, though not as effective at stimulating as spending. If you don't like temporary tax cuts because you believe in Ricardian equivalence (even though it fails empirically), permanent tax cuts are no better at stimulating.

    4) Permanent tax cuts without corresponding spending cuts are just delaying taxes- they have to paid in the future. With the permanent income hypothesis, you get that permanent tax cuts have no stimulative effect either, as people save to pay the future taxes on the tax-cut induced debt.

    5) Obama didn't make a big show of announcing the tax cut and had the tax cut take place several times in small increments because of behavioral economics research suggesting that this approach would mean more spending and less savings. See here:


    6) If you didn't save more, then you actually did stimulate the economy by spending more, as you received more income.


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