Tax Policy – Taxes and Liquidity During an Economic Crisis
The coronavirus crisis is creating an unprecedented economic shock, and lawmakers are debating how to use fiscal policy tools to stimulate the economy and accommodate businesses and households during the public health emergency. One word frequently mentioned in these conversations is liquidity, which describes whether firms and individuals have enough cash (or assets that can easily be converted to cash) to quickly and easily meet their obligations. Specifically, the coronavirus crisis is creating a liquidity crunch for businesses, as their revenues drop due to people staying home and spending less. Individuals may run into liquidity problems if they are laid off.
Taxes play an important role in liquidity and provide an opportunity for policymakers to help ease the strain for illiquid businesses.
As individuals, taxes from wage income are usually withheld from paychecks by employers throughout the year, and we file our forms with the Internal Revenue Service (IRS) once a year. However, for business filers, tax payments are a much more frequent occurrence, as U.S. businesses either pay or remit more than 93 percent of all the taxes collected in America. This is why some have argued in favor of temporarily cutting the part of payroll taxes remitted directly by employers, to help ease liquidity constraints faced by businesses. Liquidity for both individuals and businesses is why the Treasury Department has postponed the April 15 tax filing deadline and waived interest and penalties for individuals who owe $1 million or less and corporations that owe $10 million or less.
Ultimately, the goal of any policy change should be to help businesses that would otherwise be solvent but are illiquid due to the crisis, and not to prop up insolvent businesses that would not be successful under normal conditions.
We can look at how payroll taxes impact liquidity as an example. Payroll taxes are taxes on wages and salaries of employees. One major payroll tax is the 12.4 percent tax on the first $137,700 of earnings to fund Social Security. The second is a 2.9 percent tax to fund Medicare, for a combined rate of 15.3 percent. Half of payroll taxes (7.65 percent) are remitted directly by employers, while the other half (7.65 percent) are taken out of workers’ wages.
Businesses must deposit payroll tax liability with the IRS on either a monthly or semi-weekly basis, depending on the amount of tax liability they accumulate. A business that is a semi-weekly depositor would have to pay employment taxes for payments made on Wednesday, Thursday, and/or Friday by the following Wednesday, and for payments made on Saturday, Sunday, Monday, and/or Tuesday by the following Friday.
These frequent payments, along with filing a quarterly Form 941 for payroll taxes and making estimated quarterly payments for business income taxes, require businesses to have enough cash on hand to pay their tax obligations in a timely manner. Making full payments in a timely manner can become challenging in hard economic times, contributing to the liquidity crunch.
If, for whatever reason, businesses experience a significant decrease in their revenue, they must find ways to “bridge the gap” so that they can continue meeting their obligations. Thus, easing the burden of these tax payments can help businesses maintain liquidity.
As policymakers continue to work toward a fiscal policy response to the coronavirus crisis, they will certainly debate ways to help maintain liquidity until conditions return to normal. Taxes are one of the obligations that businesses must continue meeting, even during times when their revenues decline. Taxes present one policy tool available to ease the impending liquidity crunch brought on by the coronavirus crisis, which policymakers are already pursuing by postponing the tax filing deadline and waiving interest and penalties.
Source: Tax Policy – Taxes and Liquidity During an Economic Crisis