Day Nine

The Fiscal Cliff’s First Victim?

Daniel Gross on the hostage no one wants to save: the payroll tax cut.

We’re now in Day Nine of the 2012 Fiscal Cliff Hostage Situation.

On Wednesday, the CEOs came and went from the White House. Talks between Congressional leaders and President Obama are slated to kick off tomorrow. As Thanksgiving approaches, the White House is still holding the Bush-era tax cuts hostage. What’s more, automatic budget cuts that will affect major contractors are slated to kick in on Jan. 1—the same cruel day that tax rates on capital gains, income, dividends, and states rise.

In theory, it’s all open to negotiation. The tax cuts could be warded off through simple legislation. A deal could forestall some of the tax increases, or a package of tax reforms could provide higher revenue, thus obviating the need for marginal tax increases. And so while the Bush tax cuts are in jeopardy, they’re still very much alive. But the standoff may have already claimed one victim. One of the hostages is clinging to life, and will not likely emerge alive from the standoff: the temporary payroll tax cut.

The payroll tax cut—or tax holiday—was not part of the Bush-era tax cuts. Rather, it was a post-stimulus effort to goose the economy in 2011 and 2012. As Mitt Romney and his allies have famously pointed out, 47 percent of Americans don’t pay any income tax. But pretty much everybody with a job pays payroll taxes—the regressive 6.2 percent tax levied on the first $100,000 or so of income that funds Social Security and Medicare.

In late 2010, as President Obama suggested, Congress approved a temporary one-year payroll tax cut that reduced the rate from 6.2 percent to 4.2 percent. This was part of a larger package in which Congress extended the Bush tax cuts for two more years and threw in extended unemployment insurance. Since many people pay more in payroll taxes than they do in income taxes, the cut was quite meaningful. Somebody with a salary of $50,000 would see an extra $1,000 in her paychecks over the course of the year. And since such middle-income earners are likely to spend—rather than save—these tax cuts, it was a pretty effective form of stimulus. The estimated cost for 2011 was $112 billion.

Now, the beauty of a temporary tax cut is that you can always accuse the other side of wanting to increase taxes if they simply want to let the temporary measure expire as it was designed to do. That’s the tactic Republicans have been using against Democrats and Obama with the Bush tax cuts for the past several years. Obama briefly turned the tables on the Republicans over the payroll tax in late 2011. And so, at the end of 2011 with the economy growing slowly and concerns about the ability of consumers to sustain the recovery, Congress and the White House struck another deal to extend the 4.2 percent payroll tax rate through 2012. Another 12 months, another $100-billion-plus into the consumer economy.

For the past several months, both sides have pretty much assumed that the payroll tax cut would fade away at the end of the year—regardless of who won the election. Why? Republicans never really liked it; in theory, the tax cuts undermined Social Security and Medicare, which is vital to their geezer constituents. What’s more, it’s a tax cut on wages of typical workers. And for ideological and personal reasons, Republicans much prefer cutting taxes on high earners, and on investment and estates. That’s where the real money is.

As for Democrats, they have understood that, while they like the idea of a tax cut that benefits workers, it isn’t sustainable. The payroll taxes are supposed to put money into cherished programs like Medicare and Social Security. In addition, the Obama administration seems to think that if you sell something as a temporary measure for a couple of years, then it probably should be. In this Annie Lowrey article in The New York Times in September, its end was telegraphed. “This has to be a temporary tax cut,” Treasury Secretary Timothy F. Geithner told a Congressional committee. “I don’t see any reason to consider supporting its extension.”

The payroll tax may be popular among taxpayers. And a lot of economists—especially progressive ones—like it, too. It packs a pretty big bang for the buck. In a recent report, the Congressional Budget Office found that not extending the payroll tax cut and emergency unemployment benefits would reduce economic growth by .7 percent in 2013, a significant impact. But the payroll tax holiday is now “an orphan on the Hill,” as Chuck Marr, director of federal tax policy at the Center on Budget and Policy Priorities. Earlier this year, both the House and the Senate passed (apparently irreconciliable) bills that would have avoided the fiscal cliff by temporarily extending some or all of the Bush tax cuts. Neither included a reprieve for the payroll tax cut.

Sure, here and there, you can hear plaintive calls for the hostage takers and ransomers to consider the fate of the poor payroll tax cut. Marr notes that former Treasury Secretary Larry Summers has mentioned it, and some of the investment banks have noted the potential impact of a payroll tax increase on the economy. But in his public and private utterances over the past week, President Obama hasn’t indicated that it is a significant priority. This particular hostage may still be technically alive. But, as Marr concedes, “it is the one that is most at risk.”