Monday, December 5, 2011

Temporary Payroll Tax Holiday Extension Debate‏

Milton Friedman’s permanent income hypothesis basically states that consumer consumption is based more on long term expected income patterns than current income. That a determining factor of the pattern is real wealth (capital and human capital) and much less real current income. Friedman’s permanent income hypothesis blows a major hole in the Keynesian consumption function proposition. (1)

Art Laffer and other supply-siders have evidence that “tax time horizon” has influence on consumption patterns. That is, a short term tax cut is saved as the consumer knows the tax is returning in short order. Long term tax reductions cause consumption expectations to move in a positive direction as the tax reduction is long lasting/durable (long term permanent tax increases cause the reverse effect) . Hence we end with the tax time horizon proposition being to one degree or another related to Friedman’s permanent income hypothesis. (2) (3) (4)

Given the above, the current debate over the temporary payroll tax holiday extension misses the mark completely in regards to Friedman’s points of: (a) long term expected income patterns, (b) real wealth determinant. Further, payroll tax holiday extension dismisses Laffer and other supply-siders tax time horizon proposition.

Which begs the question: is the temporary payroll tax holiday extension merely politicos exercising poor economics?


(1) Theory of the Consumption Function, Milton Friedman, 1957, Princeton University Press

(2) Dr. Art Laffer,

(3) Fact vs. Fiction: Temporary Tax Cuts, Norbert Michel, Ph.D.

(4) Why Permanent Tax Cuts Are the Best Stimulus, John B. Taylor, WSJ, 11/25/2008

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