More than two years into the official economic recovery, Wall Street has reaped enormous profits while middle-class and low-income workers have been left with crumbs. The result: the Tea Party on the right, Occupy Wall Street on the left, and a President whose Gallup Poll approval rating is scraping 43 percent with less than a year before Election Day. To help alleviate this persistent economic and political tension, Barack Obama has fastened onto a simple idea: He wants to give everyone in the country a pay raise.
Last year, Obama demanded a 2 percentage-point cut in payroll taxes (that’s the 6.2 percent the government takes from your paycheck to fund Social Security) in exchange for extending the Bush Administration’s tax breaks for the wealthy. Now he’s asking to renew the payroll tax holiday, set to expire on Dec. 31, for another year—and to cut the tax by an additional 1.1 percent.
In effect, Obama’s idea is to put money directly in the hands of wage earners by raising their pay. A person who makes $50,000 would take home an extra $1,550 next year. The broader economy would benefit as people spend that cash, stirring a cycle of hiring and buying. It’s the reverse of the Republican preference for tax cuts targeted at so-called job creators, in which the benefits are supposed to trickle down from the wealthy.
Obama’s plan targets workers’ pay first and counts on the money bubbling up to stimulate overall growth. The benefits tilt toward lower- and middle-income workers, since the payroll tax is currently assessed only on the first $106,800 of earnings.
The cut will have another effect: making the economy seem like it’s growing faster than it actually is. Moody’s Analytics (MCO) Chief Economist Mark Zandi estimates it would take white-hot growth in the neighborhood of 5 percent to provide the same income gains for workers next year that an expanded payroll tax cut would likely achieve. “Labor is flat on its back,” Zandi says. “This is a very efficient way to get that money in their pockets, which policymakers probably couldn’t do otherwise.”
It isn’t lost on the White House that income growth has been the best economic predictor of how incumbents fare in Presidential and congressional elections going back to 1952. Douglas A. Hibbs Jr., a former professor of government at Harvard University and economics at Sweden’s University of Gothenburg, compared growth in real disposable income—after taxes and inflation—with a range of other indicators, including unemployment and gross domestic product. “I couldn’t think of anything that would give an incumbent President a better vote harvest than this proposal,” says Hibbs, who also supports the measure as an effective stimulus. The President’s other major economic priority as Congress rushes toward adjournment—extending unemployment benefits—also props up incomes.
So far workers haven’t benefited much from the economy’s paltry growth. Since the recovery began during the second quarter of 2009, only 26 percent of the growth in national income has gone to wages and salaries. More than half has been captured in corporate profits. The payroll tax cut Obama won for this year wound up countering the impact of surging gasoline prices and not a lot more. On average, workers’ real take-home pay has been stagnant over the past 12 months.
The payroll tax cut’s supporters say it would also provide insurance against a possible shock in the months ahead—such as an economic collapse in Europe or slowing growth in China—that could tip the U.S. back into recession. “There is no question that the payroll tax cut is quick and effective medicine to prevent the real risk of a recession in the coming year,” says Michael Greenstone, a Massachusetts Institute of Technology economics professor and former chief economist in Obama’s Council of Economic Advisers. If Congress allows this year’s temporary payroll tax cut to expire on schedule, most workers will begin 2012 with a 2 percent pay cut. That alone could cut 7/10ths of a percentage point from growth next year, Zandi estimates, probably driving it below 2 percent. Many economists believe GDP must rise by roughly 2.5 percent just to keep the dismal unemployment rate steady.
Republican leaders have opposed Obama’s plan, portraying it as a bait and switch since Democrats intend to pay for the one-year payroll tax reduction with a permanent 3.25 percent surtax on income above $1 million, beginning in 2013. “That’s an especially bad pairing,” says Douglas Holtz-Eakin, former director of the Congressional Budget Office and adviser to Senator John McCain’s 2008 Presidential campaign. “Temporary tax cuts are not very powerful. If you have a permanent tax increase, that would be much more negative.”
Obama has sought to put political pressure on Republicans, accusing them of a double standard in protecting the Bush Administration’s tax cuts for the wealthy but not a reduction that benefits the broader public. “Don’t be a Grinch,” he scolded in a Nov. 22 speech in Manchester, N.H. “Don’t vote to raise taxes on working Americans during the holidays.”
The President’s urgency is easy to understand. From his inauguration through October, average aftertax income was down 1.4 percent, never a good sign for an incumbent looking for votes. Even if Republicans relent and Obama can secure his payroll tax cut, he faces an economy that refuses to budge and a public that is increasingly losing faith in his ability to do anything about it.