Should Congress Extend the Payroll Tax Holiday?

By :: November 29th, 2011

Should Congress extend and expand the payroll tax cut it first passed a year ago? In a bizarre but not unexpected role reversal, Democrats insist that at a time of economic uncertainty, Congress must not only extend this tax cut but make it even more generous. And Republicans seem to have somehow discovered a tax break that is deeply flawed. Who is right? They both are.

With the Senate likely to vote on the issue this week, the payroll tax cut has devolved into yet another dreary black-and-white partisan debate. Yet, the consequences of a deeper cut in the payroll tax are ambiguous at best.

Yes, it will put more money into the pockets of people likely to spend it (or at the very least not take money out of their pockets). And while the economic recovery remains fragile, that is probably a good idea. About 160 million workers would benefit and supporters estimate that the expanded tax cut would be worth $1,500 for a typical family. Some Wall Street economists figure this is worth about 1 percentage point of growth. And that’s not insignificant.   

But the payroll tax holiday was poorly designed—certainly compared to President Obama’s Making Work Pay Tax Credit that it replaced. Some economists argue that because people are more aware of the payroll tax cut than they were of the obscure MWP, they are more likely to spend the extra dollars. Still, the payroll tax break has big problems.

Because it is so badly targeted, many relatively high-income workers—who are more likely to save rather than spend some of this windfall—would benefit. And if the idea is to boost the economy by increasing demand for goods and services, giving the money to savers isn’t helpful.  

At the same time, the Democrats’ proposal would halve the employer share of the Social Security tax for the first $5 million of each firm’s taxable payroll and eliminate the levy entirely for many new hires. Prior attempts to use a payroll tax cut to encourage firms to boost employment suggest that many businesses will take the subsidy for hiring they would have done anyway.

And then there is the not insignificant matter of what this means for Social Security. A major cut in payroll taxes reduces that program’s funding—and as you may have heard, Social Security already faces a significant long-term shortfall. Supporters of the payroll tax break say it is only temporary, so the dollars at stake are relatively small. And besides, they insist, the Social Security Trust fund would be made whole through transfers from the general fund.

But the government is running a $1.4 trillion deficit at the moment, so there are no general funds to fill this hole. In effect, Congress would still have to borrow more money to make up the shortfall—only it would borrow it for the general fund rather than the Social Security trust fund. Economically, it doesn’t matter. But it won’t do much for the credibility of Social Security.  

Besides, I worry about just how temporary this tax cut will be. We all know what happens to time-limited tax breaks in Washington. Like vampires, they never die. And this one will be especially tough to kill. Do you know many politicians willing to take the heat for raising taxes on working families by $1,500?      

The latest version of the payroll tax holiday would add more than $250 billion to the deficit. And it seems that with that kind of dough at stake, Obama and Congress could have done a better job designing this tax break (actually, they did--with the late MWP credit).     

There is a separate argument about how to pay for extending the payroll tax holiday. Democrats want to impose a millionaire’s surtax and Republicans don’t. But leave that argument for another day. On its own merits, extending the payroll tax cut may be better than nothing, but it isn't very good.

 

18Comments

  1. Vivian Darkbloom  ::  2:24 pm on November 29th, 2011:

    If proponents of this type of “stimulus now, austerity” later propaganda were really serious they would not fund the shortfall caused by the payroll tax holiday in the SS Trust Fund through general revenues (that is, through general borrowing). Rather, they would proportionately reduce the earnings credits of those who benefit from the current reduction. That would not only be fiscally prudent—it would be fair.

    Also, of course, no rational employer is going to increase hiring based on a *temporary* payroll tax reduction.

    Since this scheme is broad-based and targets those who tend to go to the ballot box, its primary attraction is to purchase votes.

  2. Michael Bindner  ::  4:31 pm on November 29th, 2011:

    I suspect that paying for it is not the issue – the GOP likely will use the demand for the payroll tax holiday, AMT and Doc Fix workarounds and extending extended unemployments as leverage for a repatriation tax holiday for foreign profits in advance of the increase in dividend tax rates. Only be some very obnoxious dynamic scoring can a repartriation holiday be justified – and frankly such holidays breed more holidays and American job loss. The only smart way to really pay for all this is to increase the dividend tax rate to at least 20% – or better yet 25%, along with the corporate tax rate and the capital gains tax rate. I will leave it to TPC to determine what tax rate would be required to pay for short term tax needs – however if the “middle class” tax rate is 25% and remains so, parking capital gains and dividend rates there for now seems like an equitable short term compromise.

    I agree that the Making Work Pay credit is better targeted than the payroll tax holiday – however like the Earned Income Tax Credit – it puts taxpayers in the position of subsidizing low wage labor, where an increase in the minimum wage is a better tool to deal with the problem of underpaid low wage work, especially in monopsonistic labor markets where such increases are not shown to result in job losses.

  3. David Engage America  ::  4:32 pm on November 29th, 2011:

    This is a question for Howard Gleckman and other experts.

    Why is the MWP tax credit a better tax break than the Payroll Tax Holiday?

    What are the main differences between them?

    Is there a more preferable form of stimulus than either the Payroll Tax Holiday or the MWP tax credit? If so, what?

  4. Michael Bindner  ::  4:36 pm on November 29th, 2011:

    There has long been an effort to subsidize Social Security with the general fund, although I am not sure this is what people who want that had in mind.

  5. Ralph H  ::  4:56 pm on November 29th, 2011:

    I am concerned that the payroll tax holiday will become a rolling gift to workers each year in an effort to buy support. Assuming we go with Obama, what will we do next year when the PTH and the Bush tax cuts are scheduled to end? Other than getting us through the election, what will be different? Meanwhile we are doing nothing to solve our long term debt bomb. I am concerned that SSI and Medicare will become more of a problem by these bandaids.

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  15. Rob Jones  ::  4:36 am on December 5th, 2011:

    I don’t pay payroll taxes for Social security. So, I won’t get social security. Will I help pay for social security recievers? Probably so! Making your pay was a better plan.

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