Tuesday, August 23, 2011

Why the Republicans are considering a tax increase

40411g4a9t4zpfeRecently the story that Republicans are in favor of allowing the payroll tax to increase over President Obama’s opposition has been making the rounds on the internet. The story, presented as evidence of Republican hypocrisy on taxes, is more complex than it seems.

The cut in the payroll tax stems from last year’s compromise to extend the low, Bush-era tax rates for all Americans. A provision of the compromise deal lowered the Social Security payroll tax from 6.2 percent to 4.2 percent for employees during 2011. Employers were still required to pay the full 6.2 percent for their portion of the payroll tax. The self-employment tax was also cut by two percent. If not extended, the payroll tax will return to 6.2 percent for employees at the end of the year. The employer portion will remain the same.

The tax cut obviously did not stimulate economic growth. Economic indicators have trended negative over the past few months leading many economists to predict that a second recession is increasingly likely.

Speaking to the Associated Press, Rep. Jeb Hensarling (R-TX) said, “It's always a net positive to let taxpayers keep more of what they earn, but not all tax relief is created equal for the purposes of helping to get the economy moving again."

The payroll tax cut is an example of the most ineffective type of tax cut, one that is temporary, targeted, and tiny. From the beginning, the payroll tax cut was only meant to last for a year, which means that it would not affect long term economic decisions. It was targeted to employees, and did not apply to the employer match, where it would have had a greater impact.

Perhaps most important, the payroll tax cut was tiny. For a worker earning $50,000 the two percent tax cut is worth $1,000 for the year. However, the taxpayer does not get this savings all at once. It is prorated throughout the year in each paycheck. This means that the true savings is only $83 per month. If a worker is paid weekly, it amounts to only $20 per paycheck. This is not even enough to buy a tank of gas and is barely noticeable to most workers.

Social Security payroll taxes only apply to the first $106,800 of income. Therefore, the largest savings that any worker would realize from the tax cut, no matter how much they earn, would be $2,136. This translates to $178 per month or $41 per week.

Conversely, the payroll tax is used to fund Social Security which, under current estimates, will go bankrupt by 2036. That year the trust fund will be exhausted and Social Security will no longer be able to pay benefits without using current taxes. In 2010, Social Security expenditures exceeded revenues. Social Security is already operating in the red.

For 2010, Social Security tax receipts were $865 billion according to the Congressional Budget Office. Half of this money was paid by employers and half, $432.5 billion, was paid by workers. The two percent tax cut would be equivalent to $8.65 billion. This figure is slightly more than one percent of Social Security’s 2010 expenditures of $700 billion.

Since the payroll tax cut was too small to produce economic growth, it follows that allowing it to expire would have a minimal impact on the economy. Even a small impact might tip the scales toward recession though. On the other hand, the increased revenue might be able to buy a little more time to reform Social Security before the entitlement program goes bankrupt. The money in question is a tiny part of Social Security’s annual expenditures. Neither option is likely to be palatable for Republicans.

Nevertheless, it is likely that Republicans will agree to extend the payroll tax cut. Former house speaker and current presidential candidate Newt Gingrich was quoted by Talking Points Memo as saying, “I think it's very hard not to keep the payroll tax cut in this economy. I don't know what Republicans are going to say but I think it's very hard to say 'no.' We're going to end up in a position where we're gonna raise taxes on the lowest income Americans the day they go to work and make life harder for small businesses.”

Read this article on Examiner.com



Photo credit:  Keerati / http://www.freedigitalphotos.net/images/view_photog.php?photogid=1939

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