There once was a family that sat down to do its taxes. The family usually overwitholds a small amount each year – not enough to make it a real economic cost, but enough so that it is unlikely they will have to make tax payments at tax time each year. In 2010, when they were expecting a small tax rebate, they found that they would be getting an additional $2,800 than they had planned on when they had make their consumption, saving, withholding choices a year earlier. $800 of this comes from a new “Making Work Pay” credit that I get just for being good enough to remain employed. $2,000 comes from a new child tax credit which may or may not expire at the end of this tax year. My irrationality led me to forget about the $2,000 we got last year from that credit, but the $800 credit is entirely new.
What did we do with this extra $2,800? We are sitting on it. Why? Because we have no clue whether or not these credits will be there in the future. If I knew that both would be there every year in the future, I would immediately reduce my withholding from my monthly paycheck – so that I’d be taking home roughly $150 more after-tax each and every month. We would probably save half of this and spend the other half. This savings would be channeled into discretionary retirement contributions.
However, we cannot count on these being here in the future. With the tax-loving and suddenly deficit conscious corporatists in office, we are sure to see the child tax credits expire (they are evil relics of the hack Republican-corporatists that preceded the current regime) and we have no idea about the Making Work Pay credit. My expectation is that it will go away, and beyond that, I expect my taxes to increase in order to pay for the entitlement growth and pending health reform and energy initiatives. So my wife and I are sitting on that money. We want it to be able to make our future tax payments if I get my withholding estimates wrong. We want it as a rainy day fund just in case something unexpected happens to us. We certainly are not going to spend it. We certainly are not going to use it to engage in any long-term planning or “investment” project. For example, we could sign ourselves up for memberships in various clubs or organizations that we have long wanted to do – but we do not wish to go through the work of getting into these organizations, only to have to withdraw from them later on. We may pay down some debt with it – but we really only have a 5% mortgage and a small amount of tax-favored college loan payments – so we are better off sitting on the cash.
In short, we really have no clue what to do with this $2,800 windfall, because we have no clue what will become of it in the future. And I do not think that my behavior is crazy or irrational. Now imagine a business trying to make similar decisions, but when the stakes for them are extraordinarily higher. Perhaps they made a decent profit this year. Should they expand and hire more? Maybe, but what if a payroll tax levy to pay for national health programs is instituted? That could eliminate profitability pretty quickly, and also get the business tied up in long-term investment projects and employment relationships that are costly to turn back on. Maybe corporate income taxes will increase? After all, that was a direct suggestion in the State of the Union? But maybe my industry will get favorable tariff protection? Or maybe my industry will be susceptible to increased unionization efforts? Or maybe the minimum wage laws will significantly change over my planning horizon? Or maybe environmental regulations will change during my planning horizon (e.g. so, should I build my new office to burn gas heat, where should I build it, etc.?). Do I finance my new expansion with debt or equity or via merger or other strategic partnerships (and how will the inflationary environment affect this, or anti-trust law?). These and thousands of other decisions face employers every single day. And nothing in the current policy environment is providing any sign that stability and clarity is coming any time soon.
Aside from the frictions that you would expect in a labor market when the “economy” is reallocating resources away from housing and finance and into other more valuable sectors, the regime uncertainty is, in my view, a bigger worry for those folks who worry about high and persistent unemployment.