OMB Watch: Payroll Tax Cut Extension Back on the Table?

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(Original Post)

House Budget Committee Ranking Member Chris Van Hollen (D-MD) made a few waves in October when he said that the payroll tax cut should be extended beyond the end of the year. Van Hollen noted that, given the state of the economy, extending the payroll tax cut would put money into the "pockets of working Americans who actually go out and spend that money."

The payroll tax cut is a two percentage point reduction (from 6.2 percent to 4.2) in the employee's portion of the Social Security tax withheld from every paycheck. According to the Center on Budget and Policy Priorities (CBPP), it increases take-home pay by about $1,000. It would also provide, dollar-for-dollar, more economic stimulus than an extension of the upper-income Bush tax cuts.

Enacted at the end of 2010, the payroll tax cut was intended to boost the economy. It was extended at the end of 2011 through the end of 2012. Its extension into 2013 was considered unlikely, with neither Democrats nor Republicans supporting it. However, Van Hollen's remarks and those of former Obama National Economic Council Director Larry Summers in September, indicate that what many in Washington thought was off the "fiscal cliff" negotiating table may be back on it. An Oct. 31 Politco piece noted that some congressional Democrats see a political advantage in backing a payroll tax cut extension because it could provide a stark contrast between them and their Republican counterparts who are fighting doggedly for an extension of the Bush tax cuts for the top two percent.

But there are also economic reasons to keep the payroll tax cut. The threat of economic contraction and job losses from automatic, across-the-board spending cuts (sequestration) and the expiration of the Bush tax cuts in January has motivated Congress to re-think available policy options. CBPP cites a Goldman Sachs analysis that projects the expiration of the payroll tax cut will slow the economy, reducing gross domestic product (GDP) growth by 0.6 percentage points in 2013. The analysis also notes that this reduction is the same order of magnitude as the most recent economic expansion actions taken by the Federal Reserve, so allowing the payroll tax cut to expire could cancel out the Federal Reserve’s efforts to stimulate economic activity.

Treasury Secretary Timothy Geithner threw cold water on the idea of extending the payroll tax cut in June, but last week, The Washington Post reported that the Obama administration is considering a new tax cut for workers, similar to the Recovery Act's Making Work Pay tax credit. That credit boosted workers' paychecks by up to $400 annually ($800 for couples). Citizens for Tax Justice notes that the Making Work Pay tax credit was better targeted than the payroll tax cut because a larger share of it went to working-class families.

The payroll tax cut has provided millions of families added spending money during the two years it has been in effect. But the merits of a payroll tax cut or a more targeted tax credit for workers should be judged in the context of the larger reform package in which each is contained. Its inclusion does not guarantee that the ultimate package, on balance, will benefit working families.