....One of Milton Friedman’s key achievements was working out a formal version of this idea, which is known as the “Permanent Income Hypothesis.” In short, it holds that most people are not utter fools, and that they therefore recognize temporary fluctuations in their income as temporary, and therefore as no basis for making long-term economic commitments. If your take-home pay is normally $5,000 a month, and you get a $1,000 Christmas bonus, you don’t go into January acting like a guy whose take-home pay is $6,000 a month. You act like a guy who just got $1,000 in new net worth, not $1,000 a month in new income. Likewise, if the government gives you a temporary tax break that adds $200 a month to your take-home pay, you don’t move from a $1,500-a-month apartment to a $1,700-a-month apartment, or build a $20,000 extension onto your house, or buy a $35,000 car instead of a $25,000 car. You know that the extra income won’t last forever.
That’s why the ever-burgeoning stimulus project has underperformed. It started with those embarrassing $300 checks from the 2008 Bush stimulus, which grew up to be the $400 Making Work Pay tax credit, and then provided the mutant offspring of the payroll-tax cut, which is good for a few hundred bucks for most families, and up to a couple of grand for the high-rollers. It all adds up to about $10 billion a month — not the smallest of potatoes...
And while temporary tax cuts probably aren’t very effective in general, there’s good reason to think that this one would be less effective than most. As Bryan Caplan explains, under perfectly free labor-market conditions it wouldn’t matter whether we cut the employee side or the employer side. But we have regulated labor markets (minimum-wage laws, union rules, etc.), and so it does matter. We cut the employee side rather than the employer side, which raises compensation. Cutting the employer side would have reduced the cost of labor: Prices go down, demand goes up — what is true for widgets is true for workers...
Whatever they end up doing, Republicans should fight for one more change: making the rates permanent, at whatever level they end up at. More important than a relatively modest tweak of the tax rates here and there, the fact that we’re set to have a major national political brawl every year or so over tax rates is the source of a great deal of economic uncertainty. Investors need stable rules (recent EPA adventuring is unhelpful) and a stable political-economic environment in which to operate...