How a Payroll Tax Cut Boosts the Chances for Tax Reform

By :: December 8th, 2011

When Congress finally extends the payroll tax cut that is due to expire in a few weeks, it may also be taking another step down the road to tax reform—and perhaps even to big Social Security changes as well. Why? Because without fundamental reform, it will be devilishly hard for Congress to ever get rid of an extremely generous tax break for 160 million workers.

Brian Beutler over at TPM did some nice reporting on this today, writing that both Senate Majority Leader Harry Reid and senior White House officials believe that extending the payroll tax holiday would help force a rewrite of the tax code by the end of 2012. That’s when Congress would face the triple witching hour of the expiration of the 2001/2003/2010 tax cuts, the automatic spending cuts forced by the last summer’s debt limit deal, and the likely one-year extension of the payroll tax cut.

This is largely spin. The chances of Congress rewriting the tax code next year—in the heat of election madness-- are vanishingly small. However, top Democrats are not wrong about all of these factors eventually forcing reluctant lawmakers to tackle the tax code.

And extending the payroll tax cut will only increase the pressure. Already, this tax break threatens to become another permanently temporary fixture in the law, like the Bush/Obama tax cuts and the dozens of allegedly time-limited business breaks that litter the code.  

It is, in fact, easy to see a one-year extension becoming a two-year reprieve. After all, President Obama and his GOP challenger will surely be asked during the campaign whether they’d support “raising taxes by $1,000 on American workers.” Can you imagine their answer being anything other than no?  Thus, the next president will commit to another extension of these low payroll tax rates.

In its final version, an extended payroll tax cut will probably end up adding at least $100 billion annually to the deficit and perhaps more. That will depend on what a final bill looks like—how generous the new tax holiday will be and how much of it is paid for with offsetting tax hikes or spending increases (my guess is not much).  

Extending the tax break will also increase political pressure on Social Security by continuing to cut revenue to the system. In 2010, the trust fund collected about $780 billion in payroll taxes. Simply keeping the 2011 rates would raise about 14 percent less. Of course, expanding the break, as the Democrats favor, would reduce Social Security revenues by even more.

Remember those long-ago days of, say, a month ago, when Washington was buzzing about whether to boost payroll taxes as part of a major deficit reduction deal?

Democrats say that, as they’ve done this year, they’d make Social Security whole by transferring money from the government’s general fund to the trust fund. But, of course, the government is running a $1.4 trillion deficit and has no money to transfer. It would, therefor, have to borrow the cash.

Continuing to make this transfer would fix the accounting problem but not be helpful to Social Security’s already tarnished credibility. And some conservatives gleefully see this as an opening to revisit the retirement program.

So how can Congress undo this mess? The same way it disentangles itself from its unproductive and toxic argument over the Bush/Obama tax cuts: It rewrites the tax code from top to bottom.

It won’t happen in 2012, but it is why extending this payroll tax will make reform more likely.

6Comments

  1. Michael Bindner  ::  3:18 pm on December 8th, 2011:

    Whether the tax code is rewritten this year or not depends on whether Ways and Means insists that the payroll tax extension, et al, include a repatriation tax holiday for corporate profits and a permanent 25% corporate rate as a condition to do the deal. I suspect that some donors want this to happen just in case dividend rates go to normal levels in 2013. In the short term, this only brings in revenue is you count offshore profits as permanently lost without such a holiday – which I suspect the JTC won’t do. This will require a pay-for – and the obvious pay for is letting dividend and capital gains rates expire early, raise them to 20% immediately or do a comprehensive tax reform along the lines of Bowles Simpson, but with the rate set to 25% on dividends, capital gains, high income and corporate income. I don’t think the GOP will go over 25%, which means expect a magic asterisk on Medicare spending.

  2. David Engage America  ::  11:00 am on December 9th, 2011:

    I was reading another article that said tax reform most likely will not happen until the economy is in better condition. The reasoning was that people are more willing to accept a tax overhaul during good economic times than bad ones.

    What do you think of this? Is it unrealistic to think tax reform will happen before the economy improves? If so, how much does the economy need to improve before tax reform is possible?

  3. AMTbuff  ::  7:14 pm on December 9th, 2011:

    If letting the payroll tax return to its former level is politically impossible, how is a tax increase more than twice as large going to be politically possible? Labeling it Tax Reform won’t help.

    Only a credible threat of a bond market crash will engender enough fear to prompt voters to support major spending cuts and tax increases. Until then, dreams of fiscal responsibility are fantasy.

  4. Ralph H  ::  10:51 am on December 10th, 2011:

    I agree with AMTbuff. We seem unable to raise taxes on middle income taxpayers. The trap is once a “temporary” tax cut is implemented, we do not have the political will to let it expire. Short of a major victory in 2012 by either party, I just do not see resolving this. Frankly, our best chance is some sort of gridlock which lets everything expire — but this is certainly not proactive policy.

  5. Vivian Darkbloom  ::  11:14 am on December 10th, 2011:

    Again, and again, and again: This payroll business has *nothing* to do with improving the economy, and certainly not reducing the deficit. This is just a cynical move to 1) buy votes for the next election; and 2) gain leverage in the battle over who is going to pay for our debt (or not). Those who argue here (e.g., Burman) that it is necessary economic “stimulus” or that it will improve the chances for “tax reform” (e.g, Gleckman) are just giving cover to the politicians. Sorry to say it, but this is the sad state of affairs in today’s tax policy universe.

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