Friday, February 17, 2012

Payroll tax cut has consequences

Congress has reached a deal that will extend the reduction in the payroll tax by 2 percentage points for another 10 months, along with an extension of unemployment benefits and a change in Medicare reimbursements. The payroll tax change is the clincher because, unlike the other two provisions, it affects every working American.

Democrats wanted the payroll tax extension as a continuing stimulus for an economy that is beginning to awaken from its long, deep slumber. Republicans adamantly opposed the tax cut because it would add $100 billion to the national debt. They rejected the Democrats' proposal to offset the cost with a surtax on millionaires. True to their no-new-taxes mantra — and certainly no new taxes on millionaire/billionaire "job creators" — Republicans appeared ready to go down with that ship. But then reality struck: 160 million working Americans would blame the Republicans for the $20 that disappeared from their paychecks each week if the tax cut ended. No matter how much Republican leaders wanted to protect their rich friends from a surtax, they didn't want to endure the rage of 160 million American workers.

So the Republicans caved on this one. They agreed to let the $100 billion be added to the federal debt of somewhere around $15 trillion and rising. Democrats got their way — sort of. They protected the payroll tax cut and endeared themselves to workers, even though they did have to give in on their proposal to raise taxes on the richest of the rich.

This is not, however, a win-win situation, even though both parties got something out of it. A $100 billion addition to the federal debt is not inconsequential and arguably does greater harm, long term, than its benefit as an economic stimulus in the short term. This agreement also raises the question of when Congress will ever be able to restore the payroll tax to its normal, statutory level of 6.2 percent. Whether it happens next year or 10 years from now, ending the tax cut will take money out of taxpayers' pockets, and Congress is loath to do that. Using a payroll tax cut as an economic stimulus effectively breaks the bond between the payroll tax and Social Security benefits. Since 1935, Social Security has been funded by the payroll tax on employees and employers. The tax rose as benefits rose over the years. But with this payroll tax reduction, Social Security benefits were not reduced. Thus, the payroll tax has become just another revenue stream for the federal budget, not a dedicated trust for Social Security.

Congress seems incapable of looking beyond the short term. The rising federal debt is as unsustainable here as it is in Greece or Italy. President Obama's budget proposal calls for reducing the federal deficit but does not foresee the day when the federal budget balances expenses against revenues. Therefore, the federal debt will continue to rise and rise and rise. Congress has the power to reduce spending and raise taxes to put the budget in balance, but to do so, members will have to look beyond the next election.

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