We know that tax cuts are coming—the only question is what kind. Earlier this week, President-elect Barack Obama suggested that 40 percent (about $300 billion) of his proposed economic stimulus package should come in the form of a tax cut. At least half of that tax relief is expected to be aimed at helping middle- and low-income individuals. Obama advisers have begun outlining a “temporary” $500 per worker tax credit. Aside from being temporary, this Obama policy seems nearly identical to the “Making Work Pay” tax credit he supported during the campaign.

Meanwhile, many prominent conservatives, including columnist George Will and economist Larry Lindsey, are advocating a big payroll tax cut. Indeed, both liberals and conservatives favor tax cuts targeted to low-income workers that would be implemented through a change in the employer tax withholding system. While there are differences in the details of each side’s approach, a surprising degree of bipartisan support for such tax cuts has emerged.

Sadly, this new policy, despite its obvious political appeal, will do very little to actually boost the economy. What it will do is create short-term compliance headaches for millions of employers and increase the long-term fiscal burden on future generations.

We have heard many arguments in favor of the proposed tax relief. Some claim that a worker credit will give additional income to those people who are most likely to spend it. Others say that a payroll tax cut will reduce the cost of labor and the disincentive to work, and that alleviating the burden of these taxes is a quick and easy way to grow workers’ paychecks and help stimulate demand.

In terms of the politics at play, most Democrats want tax relief for low-income households, but they don’t want to replicate the failed “rebate check” strategy used by the Bush administration in 2001 and 2008. Faced with the reality that even many middle-income households do not pay any federal income tax, Democrats are trying to offset the burden of payroll taxes on low- and moderate-income workers.

However, a refundable income tax credit is still an outlay and not truly a tax cut. Furthermore, the federal government already provides a tax credit to offset the payroll tax for low-income workers. It’s called the earned income tax credit (EITC). As former House Ways and Means Committee chairman Al Ullman said of the EITC in 1975, “we are in effect rebating to the low-income groups below $6,000 most of the payroll tax they have already paid.”

There is no real evidence that a temporary tax policy change does a lot for the economy.

Republicans have been raised on the belief that a tax cut is often the best way to jumpstart a slumping economy. While they realize that proposing a cut in the tax on capital is a losing proposition, they believe that reducing the tax on workers is both politically feasible and economically advisable. 

But how effective, timely, and administrable is a $500 worker tax credit or a temporary suspension of the payroll tax likely to be? Unfortunately, there is no reason to believe these tax cuts will do much to boost the ailing economy and plenty of reason to think they will wind up proving very costly down the road.

First, from the perspective of creating demand-side stimulus, this policy is identical to the failed rebate check strategy. There is no evidence that altering the delivery mechanism will result in markedly different behavior by consumers. The rebate checks that were sent out in 2008 failed to work because a significant majority of them were either saved or used to pay off debt. Given how much the economy has declined since then, workers are now even morelikely to save any tax break.

Second, the only significant difference between rebate checks from the Treasury and a change to employer withholding schedules is that the administrative burden of the tax withholding change is far more costly. Millions of employers will be forced to rush into their accounting department and implement a payroll change for more than 150 million workers. That will raise a series of awkward questions: What is the penalty for failing to make the withholding change on time? What is the impact on the self-employed? How quickly can these changes be expected to occur? What is the consequence of failing to change the system back again when the “tax holiday” is over?

Simply put, this will be an administrative nightmare. While many large employers with sophisticated payroll systems are likely to make this change with only modest costs (assuming the major payroll administration companies can implement the change for all their clients), smaller employers will face a much more difficult and time-consuming task.

Finally, while the objective of the tax cuts is to boost consumer demand and rejuvenate the economy, how likely is it that these tax cuts will be temporary? When it becomes clear that an economic recovery has begun, will Democrats really raise taxes on low- and moderate-income Americans? It’s doubtful. Therefore, the true cost of this proposal is likely much greater than the advertised cost, yet the near-term economic benefits are small at best.

Is there a better way for the federal government to swiftly deploy $800 billion and get the economy back on track? Maybe not. There is no real evidence that a temporary tax policy change does a lot for the economy. Furthermore, while a modest-sized stimulus package may be cost effective, there will be a diminishing return to any stimulus plan as it grows in size, regardless of whether the plan is implemented through tax cuts or spending increases. The current bidding is at $775 billion and the cost could rise to $1 trillion or more.

Congress would be well advised to err on the side of caution and take time to ensure that the stimulus policies being advocated are likely to work. U.S. lawmakers should focus on the most effective and most appropriate infrastructure spending. They should seek to improve those tax policies that adversely affect the most taxpayers.

Republicans have taken a step in the right direction by calling for an open and transparent process, and their calls have been echoed by Democrats. The next step is to focus on the principles of growth—including long-term growth— and to think carefully about the details, not just the sound-bites.

Alex Brill is a research fellow at the American Enterprise Institute. He previously served as senior adviser and chief economist at the House Committee on Ways and Means.

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