February 20, 2012

On the Hook: Payroll Tax Cut Extension Carries Hidden Costs

Veronique de Rugy

George Gibbs Chair in Political Economy
Summary

Once again, politics triumphs over good economics. I'm referring to Congress' agreement last week to pass a one-year extension of the payroll tax cut — without paying for it with corresponding spending decreases.

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This article was originally published in The Daily

Once again, politics triumphs over good economics. I'm referring to Congress' agreement last week to pass a one-year extension of the payroll tax cut — without paying for it with corresponding spending decreases.

For more than a year, payroll taxes have been 2 percentage points lower than the normal 6.2 percent. This has saved 160 million Americans an average of $80 per month. While extending this tax cut to families may feel like good news today, it is terrible news for our children.

Extending the cut won’t help the economy create jobs (there’s no saving for employers). And extending the cut on a temporary basis — even a year-long extension — will only inject more uncertainty into our murky economic situation.

Yes, reducing tax rates can help spur investment and job creation, but “temporary” tax cuts don’t. Producers and consumers know they’re, well, temporary. Making the payroll tax cut permanent would be a different story. The trouble is, payroll taxes are credited to the Social Security trust fund, where they underwrite the program’s ability to pay benefits to retirees. You can only make the payroll tax cut permanent, then, if Social Security benefits are cut by a commensurate amount.

By choosing to extend tax cuts without making benefit cuts, congressional Republicans and Democrats are once again showing what their real priorities are. As a result, policymakers will have to engage in fancy bookkeeping: replacing the lost tax revenue by borrowing money and transferring it to the Social Security trust fund. It’s hard to see how either party can claim this deal as a victory. 

This budgetary shell game is not new. It was used to “pay” for the $120 billion revenue shortfall resulting from the December 2010 tax deal. And for years, the government has been recording tax revenues from the beneficiaries of the earned income tax credit — even though their share of the payroll tax gets refunded. Don’t forget, too, that the Making Work Pay tax credit, part of President Obama’s stimulus bill, refunded payroll taxes to many of these workers a second time.

Social Security is already running a cash-flow deficit. And with the payroll tax cut extension adding to these difficulties, one hopes Congress will finally pursue fundamental entitlement reform. But why tackle a difficult policy challenge when it’s far easier to cook the books and declare victory?