Is the Curtain Finally Coming Down on the Payroll Tax Cut?

In what seems like an annual rite in Washington, DC, the extension of the social security payroll tax cut—a.k.a., the “payroll tax cut”—is once again up for debate.

The cut was first implemented in 2010 under the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010.  It provided for a 2% reduction in the employee portion of the social security payroll tax, from 6.2% to 4.2%.

The cut was set to expire at the end of 2011, but was extended to the end of February, 2012, and then ultimately through the end of the year.

But this year it’s looking like an another extension of the cut may not happen.

No political consensus to extend the payroll tax cut

With the presidential election and the prospect of a lame duck Congress looming there is little debate on the Payroll Tax Cut extension.  Concern is also centering on the still large federal budget deficits which will be partially reduced through the expiration of the payroll tax cut.  If anyone has serious intentions of extending the cut they’re laying low right now.

Very low.

If things stay as they are on January 1st, 2013 the Payroll Tax Cut will expire.

Why the payroll tax cut is a true middle class tax cut

One of the issues that make the expiration of the payroll tax cut so important is that it’s a cut that benefits the largest number of people.

It’s a true middle class tax cut.

Most wage earners pay the social security tax.  The cut isn’t means tested, subject to certain events or set up as some sort of complicated tax credit.  It’s just about as close to an across the board tax cut as it gets.  If it goes away, it will have the net effect of a pay cut for tens of millions of people.

A 2% reduction in the social security tax translates into an additional $1,000 by someone making $50,000 a year. That’s money that could be spent or invested, both of which stimulate economic growth.  The cut benefits workers earning up to $110,000.  That’s the majority of people.

Since the cut also extends to the self-employed, it can enable small businesses to hire more people.  That’s important because small businesses are the main source of job growth.

The original purpose of the payroll tax cut

When the payroll tax cut was originally implemented, it was done to provide tax relief for the vast majority of workers.  This not only raised employee paychecks, but that increase helped to stimulate a stagnant economy.

In the time since the passage of the cut, the economy has grown if only anemically.

The employment picture has also improved, with unemployment falling from over 9% to just under 8%.

What will happen to the direction of the economy in the likely event that the payroll tax cut is not extended remains to be seen.  But it’s seen as a central element in the looming, so-called fiscal cliff that’s expected to play out after January 1, 2013.

That connection alone should tell us something.

Employer portion was never reduced

Though the payroll tax cut provided a direct benefit to tens of millions of employees and small business owners, it never did benefit employers.

An aspect of the social security tax that many employees are unaware of or unclear on is that employers have always paid a matching tax.  The employee and the employer each paid 6.2% of the employee’s wages in social security tax.  (A similar arrangement exists with the Medicare portion of the tax, with each paying 1.45%)

The fact that the payroll tax cut was not extended to employers may be the reason why it didn’t generate the number of jobs that were originally hoped.  Had the payroll tax cut been extended to employers, the unemployment rate might be a good bit lower than it is right now.

As a small business owner the tax cut is nice for my actual paycheck (I pay myself a salary as a C-corp) but I’m still getting hit with the 6.2% I have to pay as the business owner.  This is just for me now.  If I had more employees then you can easily see how that 6.2% employers pay can easily add up to a lot of money.  It’s a lot more than the roughly $20 per paycheck the average worker is getting.

It was always temporary

To be fair, the payroll tax cut was always intended to be temporary.

It was even referred to as a “payroll tax holiday” and we all know that all holidays end.  Treasury Secretary Timothy Geithner is not supporting its extension, nor has the White House made any effort toward continuing it.

With the usual campaign promises to cut the federal deficit, the termination of the payroll tax cuts might create some progress on that front absent any other efforts.  Meanwhile, some economists are arguing that the negative effect on the economy from termination of the cut will be minimal.

Opposed because money was meant for social security

One of the issues with the payroll tax cut from the start is that it is in direct conflict with another popular political platform—shoring up social security.

Since the payroll tax cut reduces payments into social security, it accomplishes the exact opposite.

Social security, and its funding, is a hot button issue—the “third rail of American politics.”  Supporting an extension of the payroll tax cut may be seen as a strike against the elderly, a position no politician up for reelection wants to take.  That guarantees that an extension debate will be pushed past the election at a minimum.

The payroll tax cut is built into taxpayer expectations

From it’s inception, the payroll tax cut has been seen as a way to stimulate the economy.

But beyond that, it’s become entrenched in taxpayer expectations (not unlike how those who benefit from the Bush tax cuts feel).  This is especially true given the reality of small pay increases and a still weak job market. The payroll tax cut has been one of the few bright spots related to income in the past few years.

Finally

If it goes away, spending plans may be cut. After that job losses may follow, putting the economy dangerously close to where it was before the payroll tax cut.  Some analysts have estimated that as many as one million jobs will disappear as a result of the end of the payroll tax cut.

Though it’s nice to get a boost in your paycheck, the Payroll Tax Cut has some long-term implications in that we’re using debt to pay for it.  That’s a big part of why it was meant to be temporary.  Still, it will hurt some families that depend on every dollar in their paycheck.  If the country can’t cover its bills how will the people?  To say the economy isn’t where we would like it would be an understatement.  But keeping the Payroll Tax Cut may not be the best way to move the economy along.

What are your thoughts on the looming expiration of the payroll tax cut? Do you think it should be extended another year?  Or made permanent?  Or should it also be expended to include the employer’s portion?  What do you think will happen when/if it does expire?