Creating even more uncertainty for January payroll taxes, the U.S. House of Representatives today rejected legislation the U.S. Senate had recently approved to extend the 2011 payroll tax holiday for the first two-months of 2012.

Senate Democratic and Republican leaders, unable last week to hammer out a compromise on how to pay for President Obama’s proposed extension of the 4.2% employee payroll tax rate for all of 2012, had negotiated a two-month extension through February 29, assuming that the House would go along and work out a final agreement on a full year extension in February.

Meanwhile, the National Payroll Reporting Consortium (NPRC), a nonpartisan organization of payroll service providers, said the Senate-passed bill might be unworkable as written. The group pointed to a provision in the bill establishing an $18,350 cap on wages to which the 4.2% payroll tax rate would apply during January and February. Wages paid in those months above $18,350 would be subject to a 6.2% payroll tax rate. Read more.

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Payroll Tax Holiday Debate: The Real Issue

Tue Dec 20, 2011

Creating even more uncertainty for January payroll taxes, the U.S. House of Representatives today rejected legislation the U.S. Senate had recently approved to extend the 2011 payroll tax holiday for the first two-months of 2012.

Senate Democratic and Republican leaders, unable last week to hammer out a compromise on how to pay for President Obama’s proposed extension of the 4.2% employee payroll tax rate for all of 2012, had negotiated a two-month extension through February 29, assuming that the House would go along and work out a final agreement on a full year extension in February.

Meanwhile, the National Payroll Reporting Consortium (NPRC), a nonpartisan organization of payroll service providers, said the Senate-passed bill might be unworkable as written. The group pointed to a provision in the bill establishing an $18,350 cap on wages to which the 4.2% payroll tax rate would apply during January and February. Wages paid in those months above $18,350 would be subject to a 6.2% payroll tax rate.

In a letter to House and Senate leaders NPRC urged Congress to reconsider the wage cap, saying there was insufficient lead time to program and test payroll systems to implement the $18,350 wage cap. Given the now very short time to implement any change, they advised Congress at this late date to focus on payroll tax rates and not make major changes in withholding requirements.

Today’s acrimonious House debate and vote underscores the wide philosophical chasm that separates Republicans and Democrats over issues of economic policy and federal budget deficits. While media attention has focused on the two-month versus twelve-month debate, the real issue has been and remains how to “pay for” the full twelve month cost of a 2% payroll tax cut: $105 billion.

Republicans and Democrats, including President Obama, almost unanimously agree that new laws must not worsen the federal budget deficit or public debt—which is the sum total of all previous annual deficits. In short, new government spending or tax cuts must be “paid for,” i.e., offset by spending cuts or tax increases elsewhere.

And therein lies the real difficulty Congress faces in extending the 2011 payroll tax holiday through the year 2012: how to pay for it?

First some cost numbers: President Obama’s original stimulus package, proposed in September, included expanded payroll tax cuts for 2012 for both employees and employers, with an eye-popping price tag of $240 billion. Congress balked at the President’s “pay for”—capping individual tax deductions at 28%.

The fallback was a simple extension of the 4.2% employee-only payroll tax holiday for all of 2012 at a cost of $105 billion. Predictably, Republicans and Democrats deadlocked over the pay-for: Democrats wanted to increase income tax rates for high-income households; Republicans wanted to extend a pay freeze on government employees and make other spending cuts.

Complicating matters, Congressional leaders tried to make the one-year payroll tax holiday extension more palatable by packaging it with an extension of unemployment insurance and a delay in scheduled cuts in reimbursements to health care providers under Medicare, the so-called “Doc Fix.” While smart politically, the larger package raised the pay-for stakes to $190 billion, ironically making the climb to consensus even steeper.

Unable to agree on how to pay for the one-year payroll tax break and the other provisions and with the Christmas Holidays looming, Senate Republican and Democratic leaders and the White House did the best they could—they settled for a two-month extension of the 4.2% payroll tax holiday, UI benefits and the “Doc Fix” at a total cost of “only” $32.4 billion. The pay-for was easier too: an increase in fees for Fannie Mae and Freddie Mac housing loans. No controversial tax increases or government spending cuts.

The good news was that payroll tax rates for 160 million workers would not increase to 6.2% in less than two weeks. And that translates into real money: a tax saving during January and February of about $165 for someone earning $50,000 per year; $330 for the $100,000 earner.

But the bad news was continued uncertainty about payroll tax rates. Even assuming the House of Representatives went along with the Senate’s two-month extension, Congress and the President would need to revisit the whole debate again in two months.

Today’s vote shows that Senate leadership assumed too much—the House of Representatives was not prepared to go along with a two-month extension. Indeed, the House earlier in December had voted for a one-year extension of the payroll tax holiday, adding an amendment to force the President to make a go/no-go decision on the Keystone XL oil pipeline project.

Now the House of Representatives and the U.S. Senate have passed conflicting bills: the House version extending the 4.2% payroll tax cut for all of 2012 and the Senate’s extending it for only January and February. If Republicans and Democrats are unable to resolve their differences, especially on the real issue of the “pay for,” the employee payroll tax rate will rise to 6.2% on January 1—in less than two weeks.

No one can predict the outcome of the payroll tax cut debate. Congress could decide to extend the 2011 4.2% tax rate for two months, three months or longer or, if they remain deadlocked, allow payroll tax rates to revert to 6.2% on January 1. We can only hope that Republicans and Democrats, like old Ebenezer Scrooge of A Christmas Carol, will have a change of heart at this special time of year and resolve this issue soon in the interests of 160 million workers and America’s payroll and HR professionals.