Bloomberg News

Payroll Tax Cut Heads for Lapse as Lawmakers Doubt Policy

June 27, 2012

Four months after reaching a bipartisan agreement to extend a payroll tax cut through 2012, U.S. lawmakers and President Barack Obama are showing little fervor for continuing the break, which puts about $1,000 a year in an average worker’s pocket.

House Republicans don’t plan to include it in a bill they want to pass next month that would extend Bush-era income tax breaks expiring at the end of the year. In his speeches, Obama praises the payroll provision without proposing to keep it.

“I doubt that there is any enthusiasm for taking that issue up prior to the end of the year,” said Representative Tom Price of Georgia, chairman of the Republican Policy Committee.

The collective shrug for a policy designed to encourage consumer spending and growth comes even as the U.S. economy shows signs of continuing weakness. The unemployment rate has declined by 0.1 percentage point since February and gross domestic product increased by 1.9 percent in the first quarter.

Democrats and Republicans have similar -- and differing -- reasons for their reluctance. Leaders in both parties worry that the payroll tax cut could eventually undermine the Social Security trust fund. Republicans say the tax break hasn’t done much good.

Money in Pocket

“I’m all about making sure people have more money in their pocket,” said Representative Patrick Tiberi, an Ohio Republican on the Ways and Means Committee. Still, he said, “no one has shown anybody that the payroll tax has helped the economy.”

House Republicans say they will vote in July to extend all of the expiring tax cuts first enacted in 2001 and 2003, preventing a year-end increase in tax rates for income, capital gains, dividends and estates. Those rates, Tiberi said, are the ones constituents mention to him when they cite uncertain tax policy as a reason for delaying investment decisions.

Obama rallied public support and put pressure on Congress to extend the payroll tax cut through 2012. He sometimes mentions the law during speeches, taking credit for it. Still, he hasn’t sought another extension, ruled one out or explained what should happen to the provision at the end of 2012.

Temporary Measure

“The payroll tax cut was intended to be a temporary measure to give middle class families relief during these difficult economic times,” Amy Brundage, a White House spokeswoman, said in an e-mailed statement. She added that the administration has proposed other tax policies to benefit those workers, including extensions of the current income tax rates for all but the highest earners and expanded tax credits for low-income workers and families with children.

Though the tax cut didn’t lead to economic growth, letting it lapse would hurt the taxpayers who are benefiting, said J.D. Foster, a senior fellow at the Heritage Foundation, a Washington organization that favors limited government. He said Obama was correct when he said that early 2012 was a terrible time to raise taxes.

“If Republicans are paying attention, they’re going to realize that all of those families, a lot of them, vote,” Foster said. “And they might want to think about not raising taxes on middle-class families.”

The tax, dedicated to Social Security, applies only to the first $110,100 of wages in 2012. The U.S. kept Social Security’s trust fund whole by borrowing from the general fund, which runs a deficit.

ATM Machine

Some Democrats may be reluctant to support payroll-tax cut extensions because of concerns about using the tax dedicated to Social Security as “kind of an ATM machine,” said Representative Jan Schakowsky, an Illinois Democrat who is a co- chairwoman of Obama’s presidential campaign.

“There are some who worry that if they were to become a permanent fixture, that could damage the Social Security trust fund,” Schakowsky told reporters and editors at a Bloomberg Government luncheon yesterday.

Congress first passed the payroll tax cut in December 2010, as part of a deal between Obama and Republicans that extended expiring income tax cuts. Employees now pay 4.2 percent of their wages, instead of the usual 6.2 percent, meaning that a worker making $50,000 a year who is paid twice a month saves $41.67 in every paycheck.

Under Pressure

Democrats and Republicans sparred over the payroll tax cut at the end of 2011 and beginning of 2012. Republicans initially paired a one-year extension with spending cuts and then relented under pressure from Obama for a deficit-financed break.

“Allowing this tax cut to expire would make people’s lives harder right now,” Obama said Feb. 14 in urging Congress to pass the year-long extension. “It would make their choices more difficult.”

The final bill passed the House 293-132 and the Senate 60-36, including support from a majority of House Republicans.

The expiration of the payroll tax cut represents more than 15 percent of the so-called fiscal cliff facing at the end of 2012. The combination of scheduled spending cuts and tax increases would probably push the economy into recession if Congress doesn’t alter some of those policies, according to the Congressional Budget Office.

Senator Max Baucus, chairman of the Senate Finance Committee, said he thought the payroll tax cut helped the economy. He didn’t commit to seeking an extension.

“Everything’s on the table,” said Baucus, a Montana Democrat. “It all depends on all the various provisions and tradeoffs.”

Economic Weakness

Because the case for the payroll-tax cut was based on economic weakness, Democratic calls for an extension could also indicate continued sluggishness as Obama seeks re-election.

Representative Sander Levin of Michigan, the top Democrat on the Ways and Means Committee, said Republican action or inaction between now and the end of the year will determine whether the payroll tax cut is necessary.

“It is up to Republicans in Congress to move to help economic growth now,” he said in an e-mailed statement.

Republicans make two main arguments against extending the payroll tax cut. They say it doesn’t work and that it undermines Social Security.

“It’s always good when you let people keep more of their hard-earned money,” said Representative Geoff Davis, a Kentucky Republican. “But the bigger question is the damage done to the long-term solvency of Social Security.”

Divided on Effect

Economists are divided over the effects of the payroll tax cut.

The tax cut “essentially evaporated” when it first took effect in 2011, said Dean Maki, chief U.S. economist at Barclays Plc in New York. The benefits, he said, were outweighed by higher income-tax bills, rising gasoline prices and the expiration of a tax credit more targeted at low-income workers that had been part of the 2009 stimulus law.

“It didn’t provide as much of a boost to economic activity as many expected,” Maki said.

In a CBO analysis of policy options for economic growth, payroll tax cuts ranked ahead of business tax cuts and infrastructure spending and behind aid to unemployed workers. CBO estimates that every dollar in payroll tax cuts raises the gross domestic product by 16 cents to one dollar.

The payroll-tax cut puts money directly in the hands of consumers who are likely to spend it, said Ethan Pollack, a senior policy analyst at the Economic Policy Institute, a Washington group that favors ideas that benefit low- and middle- income workers.

Consumer Spending

“In the short run, we want additional consumer spending because that will create jobs and get the economy back on track,” said Pollack, who said he would prefer more aid to states and expanded unemployment insurance, both of which are more politically difficult. “If the question is, is it better to have the payroll-tax holiday or nothing, I would say it’s better to have it.”

Maintaining that the payroll tax cut reduces the balance of money in the Social Security trust fund is bogus, Foster said, because of the general fund transfers.

Republicans also sometimes argue that financing Social Security from the general fund damages the conceptual link between the tax and benefit sides of the program.

“Your hurt the integrity of the system when you are replacing that money with general fund money,” Tiberi said.

Representative Bill Pascrell, a New Jersey Democrat, said he wants to extend the payroll tax cut and expand it to employers, as Obama proposed last year. Like employees, employers typically pay 6.2 percent of wages toward Social Security; that rate hasn’t changed. Expanding the payroll tax cut is better, Pascrell said, than extending income tax cuts for high earners.

Foster, of the Heritage Foundation, said Congress should wait to let the payroll-tax cut expire until the economy has recovered and lawmakers start overhauling the tax code.

“This becomes a driver for tax reform,” he said. “And this becomes part of the mix.”

To contact the reporter on this story: Richard Rubin in Washington at rrubin12@bloomberg.net

To contact the editor responsible for this story: Jodi Schneider at jschneider50@bloomberg.net


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