painless-payroll-tax-holiday.pngThere’s an old joke about the king who assembled all his economists and asked them to distill all economic wisdom into a single sentence. They worked and worked and finally gave the king this advice: “There is no such thing as a free lunch!”

Apparently Congressional Democrats and Republicans haven’t heard this story because last Friday they approved legislation to extend the 2% payroll tax holiday, at a cost of about $100 billion for the remaining ten months of 2012, without any budgetary offsets, i.e., without corresponding spending cuts or tax increases.

Signed into law by the President on Wednesday, the measure includes provisions to extend unemployment benefits and postpone scheduled cuts in Medicare reimbursements for physicians, within the next few days. Read more.

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Painless Payroll Tax Holiday: Free Lunch?

Fri Feb 24, 2012

painless-payroll-tax-holiday.pngThere’s an old joke about the king who assembled all his economists and asked them to distill all economic wisdom into a single sentence. They worked and worked and finally gave the king this advice: “There is no such thing as a free lunch!”

Apparently Congressional Democrats and Republicans haven’t heard this story because last Friday they approved legislation to extend the 2% payroll tax holiday, at a cost of about $100 billion for the remaining ten months of 2012, without any budgetary offsets, i.e., without corresponding spending cuts or tax increases.

Signed into law by the President on Wednesday, the measure includes provisions to extend unemployment benefits and postpone scheduled cuts in Medicare reimbursements for physicians, within the next few days.

The good news is that workers and payroll professionals can now be certain that the employee payroll tax rate for all of 2012 will be 4.2%–that it will not revert back to 6.2% at the end of February or any other time before December 31, 2012.

The payroll tax holiday is worth about $1,000 this year to the average worker, up to a maximum tax saving of about $2,200. It amounts to a saving of about $80 per month for the average worker. In this still-weak economy with high unemployment and relatively stagnant wages, payroll tax relief is most welcome good news for some 160 million American workers.

But the bad news is that this payroll tax break won’t be paid for. Its $100 billion cost will simply be tacked on to the federal budget deficit for this year and loaded on to the existing public debt burden.

Of course there was never any doubt that Congress and the President would agree to extend the 2% tax holiday through all of 2012. As reported in January, the tax break makes economic as well as political sense—especially in a presidential election year. An election year “tax cut for the middle class” is a political no-brainer.

The problem for Capitol Hill, however, was figuring out how to “pay-for” it. Just before their December recess for the Holidays Democrats and Republicans squared off in a nasty debate over how to offset the cost of the payroll tax break, with one party pushing for higher taxes on the rich and the other party pushing for cuts in the federal government workforce. They couldn’t resolve their differences and finally agreed on a two month extension until February 29, 2012.

Having a dollar-for-dollar $100 billion offset was considered essential because new federal budget figures painted a worsening picture of Washington’s annual deficit and accumulated public debt—a $1 trillion deficit for this fiscal year and probably the next and gross public debt pushing above $15 trillion, with no end in sight. Meanwhile the President last week projected the public debt to exceed $17 trillion by the year 2021, by then almost equal to the size of the entire U.S. economy!

But the chasm that has developed between Democrats and Republicans in Washington DC has grown so huge that senators and representatives were unable to compromise on the “pay-for” for the payroll tax holiday. Democrats insisted on tax hikes; Republicans refused to budge on spending cuts. With compromise impossible in this polarized environment, the political necessity of extending a tax cut for the middle class trumped the budgetary importance of offsetting its $100 billion cost.

Which takes us back to the old story of the king and his economists. Apocryphal it may be, but the fundamental truth cannot be denied: there is no such thing as a free lunch.

Sooner or later the $100 billion cost of the payroll tax holiday will be paid for. Right now that $100 billion, earmarked for the Social Security Trust Fund, will instead be channeled back into the pockets of workers. But the U.S. Treasury will need to sell $100 billion in additional Treasury debt to come up with the cash to replenish the Social Security Trust Fund. And the U.S. Treasury and American taxpayers, either in this generation or the next, will ultimately have to pay back the funds borrowed for this purpose.

Congress has decided not to worry about a “pay-for” this year. But one day, hopefully when the economy is healthier and the federal budget closer to balance, there will be a “pay-for,” either in the form of higher taxes or lower spending. The king’s economists were right: There’s no such thing as a free lunch.