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ncome tax cuts stimulate demand by putting more money into consumers' pockets. That's important because consumer spending drives 70 percent of economic growth. It then creates jobs when businesses ramp up production to meet higher demand. A study by the Congressional Budget Office found that the Bush tax cuts would create 4.6 jobs for every $1 million if extended into 2011-2012.
However, there is some debate over whether tax cuts for higher income families create as many jobs as tax cuts for low- and moderate-income families. The theory is that lower income families must spend the tax cuts, driving demand, while higher income families will save their tax cut. Furthermore, higher income family spending is less influenced by tax cuts because they families can maintain their spending by cutting into their savings, or getting loans or credit. Their tax cuts are more likely to be used to pay back loans.
Payroll tax cuts are one of the most cost-effective ways to increase jobs. According to the CBO, every $1 million in payroll tax cuts creates 13 new jobs. Payroll tax cuts create jobs in four ways. First, some companies use the savings to reduce prices. That increases demand, which necessitates hiring more workers.
Second, other companies raise wages to retain good workers, who would then spend more, increasing demand.
Third, some firms keep the tax savings, allowing them to buy more and increase demand. Fourth, companies that already had popular products would use the savings to hire more workers. This fourth method is the most cost-effective way to create jobs.
In fact, if Congress only gives payroll tax cuts for new hires, then every $1 million in payroll tax cuts creates 18 new jobs.(Source: "The Economic Outlook and Fiscal Policy Choices," Congressional Budget Office, September 28, 2010)
