payroll-tax-holiday-deja-vu.pngA top priority for Congress this month will be deciding the fate of the payroll tax holiday.

We saw the preview of this movie in December when lawmakers, unable to reach agreement on a full-year extension of the 2011 Social Security tax break, finally settled on a two-month extension after a bitter partisan debate.

Will the 2% payroll tax holiday be extended for all of 2012? Or will it fall victim to the Republican versus Democrat legislative dysfunction that has imperiled other initiatives? Read more.

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Payroll Tax Holiday: Déjà vu All Over Again

Wed Jan 25, 2012

payroll-tax-holiday-deja-vu.pngA top priority for Congress this month will be deciding the fate of the payroll tax holiday.

We saw the preview of this movie in December when lawmakers, unable to reach agreement on a full-year extension of the 2011 Social Security tax break, finally settled on a two-month extension after a bitter partisan debate.

Will the 2% payroll tax holiday be extended for all of 2012? Or will it fall victim to the Republican versus Democrat legislative dysfunction that has imperiled other initiatives?

First, it’s important to note that there’s near unanimous agreement in Washington DC that the payroll tax holiday should be extended through the end of 2012. President Obama supports a one-year extension; most Congressional Democrats support a one-year extension; and most Congressional Republicans support a one-year extension.

The reason a big majority of elected officials support a full-year Social Security tax break is because they think it makes sense economically and politically. The economy is still weak. Unemployment remains way too high. And an economic crisis in Europe could drag the U.S. back into recession. Many economists say the fledgling recovery needs a boost from continuing the payroll tax cut.

Politically it’s a no-brainer. President Obama has positioned the extension as a “tax cut” and suggests that allowing it to expire would represent a tax increase on the middle class. No politician wants to vote for middle class tax increases in an election year.

So why isn’t a one-year extension of the payroll tax holiday a slam-dunk? The answer is that cutting the Social Security tax rate from 6.2% to 4.2% for 160 million workers for a full year adds about $105 billion to the federal budget deficit.

Put another way, while support for a one-year payroll tax holiday is strong, even stronger is opposition to worsening the federal budget deficit—already projected to exceed $1 trillion this fiscal year, pushing the gross public debt north of $15 trillion. With anxious eyes watching the European sovereign debt crisis unfold,U.S.politicians are wary about adding to the deficit at a time when the federal government is already borrowing about 40 cents of every dollar it spends.

In short, a one-year extension of the payroll tax holiday for employees must be “paid-for,” i.e., offset by spending cuts or tax increases elsewhere in the budget. And therein lies the heart of the dispute between Democrats and Republicans: unanimous agreement to extend the tax cut but bitter disagreement on how to pay for it.

Predictably, Democrats will call for raising taxes on high-income earners to pay for the one-year payroll tax break. Just as predictably, Republicans will urge cuts in government spending, specifically by continuing a pay freeze on federal workers. Neither of these ideas will fly in 2012. Does that mean the payroll tax holiday will end on Feb 29?

Few things are certain in Washington DC. No one knows whether President Obama will be re-elected in November. Who can predict what the Supreme Court will decide in June on the constitutionality of healthcare reform? And it’s impossible to say what Congress will do to reduce our government’s titanic public debt, reform the tax code, strengthen Social Security or restructure Medicare. But about one thing we can be certain: Congress will never raise taxes in an election year.

In other words, notwithstanding fair questions about the diversion of funds earmarked for Social Security, whether it really will stimulate the economy or if an extension now will make it difficult to shut off at the end of this year, the 2% payroll tax holiday will be extended for the rest of 2012.

Expect the usual partisan jockeying in the next few weeks as each side accuses the other of needlessly jeopardizing middle class tax relief.. Expect the usual brinkmanship as the clock ticks down and the payroll tax cut nears expiration. And expect the usual White House calls for Congressional compromise in the national interest.

At the end of the day Democrats and Republicans will come together and find a way to pay for a full-year Social Security tax holiday—saving the average worker over $1,000 in taxes for 2012. That’s worth waiting for!