(Bloomberg Opinion) -- In his address to the nation about the coronavirus this week, President Donald Trump called on Congress to pass a payroll tax cut. It does not appear inclined to — and that could be a mistake of catastrophic proportions.
A payroll tax cut may be America’s best hope for preventing Covid-19 from sparking a long and painful recession. It would be a response not so much to the pandemic itself, which requires more spending on public health and short-term economic relief, but to the recession the pandemic will cause (and that that the market sees as all but inevitable).
It is now clear that what is necessary is a stimulus of unprecedented size and scope. Trump’s proposal of eliminating the payroll tax for employers and employees until the end of the year would be the most sweeping economic stimulus in U.S. history. It would infuse roughly $950 billion into the economy over nine months, or about $317 billon per quarter. For comparison, the 2009 stimulus was $800 billion over more than two years, or less than $100 billion per quarter.
Trump’s specific proposal may be unrealistic, but the general idea is sound. A payroll tax cut is unique in that it can put into effect quickly and at scale. No other tax can be reduced so much without causing major incentive disruptions. Spending proposals would take months to ramp up and would be difficult to do efficiently. Even ambitious cash-grant proposals are typically one-seventh the size.
This size and speed is crucial to achieving the most important goal: Preventing the coronavirus shock from turning into a long recession that pushes workers to the sidelines for a decade or more.
It is generally agreed that the coronavirus will produce a shock to global supply chains. Less appreciated is that it already has created a global demand shock. That shock will only intensify as countries around the world enact aggressive (and necessary) quarantine measures. Supply shocks come and go, but demand shocks have a self-propagating quality.
Businesses will fail because of lost demand during the outbreak. Some sectors, such as travel and leisure, are especially vulnerable, but nearly every consumer-oriented business will suffer. Those that survive will probably have to suspend hiring or lay off employees.
That decrease in job growth could then lead to declines in consumer spending. This is particularly painful, because after the lean crisis months business will need consumer spending to grow. To the extent that workers have lost their jobs or are concerned about their ability to find a new job, that post-crisis boom will be muted.
A muted boom will then depress business decisions about investment and new hires. In a sense, businesses will wait to see that their customers and clients are coming back before ramping up investment themselves. In doing so, they will depress demand for each other’s services.
Normally, the Federal Reserve responds to these types of problems by lowering interest rates. Lower rates can bring about investment in new projects, breaking the logjam and reversing the feedback loop: More investment leads to more hiring, which leads to more sales, which leads to more investment.
The Fed, however, does not have much room to lower interest rates. Indeed, investors are already predicting the Fed will need to lower rates to zero before the end of March, when the effects of the virus will still be growing. Meanwhile, investors are pouring into U.S. Treasury bonds, sending 10-year yields lower than what they were during the Great Recession. That’s a sign that they expect the Fed to keep interest rates low for a long time.
The implication of all this is that the economic shock from the coronavirus will continue to linger. Indeed, this sort of prolonged hangover happened in parts of Europe after the Great Recession, and it took Japan a decade (by the most optimistic measures) to recover from its 1989 crash.
If the U.S. is not able to bounce back quickly after the virus passes, it risks the same fate.
To be clear, the immediate need is health-care spending and humanitarian aid, as well as targeted economic assistance. To avoid a devastating recession, however, the government will have to take bold, swift action now that all but guarantees a miniboom after the pandemic is over. Just as important, investors have to be confident that the miniboom is coming even while the crisis is ongoing.
That’s why an obvious, clear and overwhelming stimulus — a payroll tax cut, if not a payroll tax suspension — is required. It’s insurance against a lost decade.
To contact the editor responsible for this story: Michael Newman at mnewman43@bloomberg.net
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
Karl W. Smith, a former assistant professor of economics at the University of North Carolina and founder of the blog Modeled Behavior, is vice president for federal policy at the Tax Foundation.
©2020 Bloomberg L.P.