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The US Fiscal Response to Coronavirus will Probably Disappoint Us

Ernie Tedeschi
Mar 10 · 4 min read

President Trump is going to Congress today to propose, among other things, a payroll tax holiday and some form of augmented sick pay for hourly wage workers who don’t already have it. These measures are meant to help ease the economic pain brought on by the coronavirus.

In a situation like the present where the US faces economic headwinds that could potentially cause a recession, any fiscal stimulus is better than none.

But it would take a very large payroll tax cut to offset the larger estimates of COVID-19’s impact on the US economy even under conventional economic modeling. And conventional economic assumptions may be wrong in a world where a pandemic is making consumers more reluctant to spend money.

Let’s say Congress agreed to cut Social Security payroll taxes temporarily by 2 percentage points, mimicking what the Obama Administration did in 2011 & 2012.

That would be a $130 billion tax cut over the next 12 months. But we’re already a quarter of the way through the year, so even if one were enacted tomorrow by end-December the impact would only be about 75% of that. If we assume a multiplier of 1, then when all is said and done a 2pp payroll tax holiday would probably offset about +0.4 percentage points of economic pain from coronavirus in 2020. [1]

Combine that with another +0.4 percentage points to 2020 GDP from the Fed cutting all the way to zero [2], as the market widely expects, and together fiscal and monetary policy can offset about 0.8 of GDP hit.

But that’s not enough to cover the worst-case scenarios. The OECD, for example, marked down US GDP by only -0.1 percentage points in its baseline 2020 forecast, but simulated a downside risk possibility where the economy contracts by -1.4 percentage points. This policy mix would only offset half of that. And some downside scenarios from other independent forecasters show even greater impacts.

Moreover, while payroll tax cuts are better than no fiscal stimulus at all, they aren’t particularly well-suited to the current shock. Payroll tax cuts only dribble out their benefits gradually, a little bit with every paycheck, so we wouldn’t get a full 12-months of stimulus from them by year’s end. And the people most vulnerable to the economic impacts of the coronavirus — those without jobs, those who stand to lose pay or hours, and the lowest-wage workers — are precisely those who stand to see no or low benefits from a payroll tax holiday.

We could simply scale up the payroll tax holiday — a five-percentage-point cut would be enough in tandem with a Fed zero rate to match the OECD’s US risk case for 2020 — but so far it appears that even a 2-percentage-point cut will be a tough sell to Congress.

A better solution would be to send Americans lump-sum rebate checks. That would deliver economics benefits faster and in one fell swoop, and give lower-income families some cushion with which to pay unanticipated expenses — though fiscal stimulus isn’t nearly enough on its own; here the Trump Administration’s idea to augment sick pay for hourly wage workers sounds like a positive step. Jason Furman’s idea to give $1,000 to every adult and $500 to every kid is a roughly-$300 billion idea that would boost 2020 GDP by 1.2 percentage points. Combined with Fed rate cuts, that would be enough to cover some downside risk scenarios from the virus. [3]

But if a 2-percent payroll tax holiday already faces an uphill battle, it’s hard to see a rebate check idea doing any better politically, especially without Trump Administration support.

So in the end, the initial fiscal response is probably going to disappoint markets and fall short of the worst-case economic scenarios. It will prove better than nothing, but hopefully federal policymakers will try for another bite at the apple soon.


[1] I use a multiplier of 1 for simplicity and because it sits about in the middle of the range of estimates published by CBO. In the current environment, there are reasons to think the fiscal multiplier might be on the lower side (e.g. virus-related risk aversion) or alternatively might be on the higher side (an accommodative Federal Reserve that won’t counteract fiscal policy in the short-term).

[2] Based on simulations using the Fed’s workhorse FRB/US model, assuming purely backwards-looking expectations. As with fiscal multipliers, there are reasons to suspect the effects of conventional monetary policy might be higher or lower than normal right now.

[3] I use Compute Studio’s Tax-Brain to simulate the idea here.

Ernie Tedeschi

Written by

Economist & budget wonk. Fmr @USTreasury economist. Data viz enthusiast. Everything here is my own opinion, and RTs/favorites are not endorsements.

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