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More Payroll Tax Cut Problems – Sets Up Future Hostage-Taking

Supporters of the tax bill are angered at the way the super-rich held America hostage for their giant tax cuts, but say that the ability to grow the economy in the next two years makes it a compromise worth supporting, a bitter pill but one that they’ll take. The refundable tax credits from the stimulus, the extension of unemployment benefits and the payroll tax cut (which disproportionately helps wealthier workers) will provide stimulus to the economy, in this reading.

First of all, most of this extends current policy, so the idea of a stimulus from this is debatable. But to the extent there is one, it will work in exactly the wrong way, at least from the perspective of the party in power. Most of the actually stimulative things in the bill, UI and the payroll tax, end in 2011, not 2012. As Paul Krugman notes, this sets up a situation where this “stimulus” peters out right before the election.

This has big political implications. Political scientists tell us that voting is much more strongly affected by the economy’s direction in the year or less preceding an election than by how well the nation is doing in some absolute sense.

When Ronald Reagan ran for re-election in 1984, the unemployment rate was almost exactly the same as it had been just before the 1980 election — but because the economic trend in 1980 was down while the trend in 1984 was up, an unemployment rate that spelled defeat for Jimmy Carter translated into landslide victory for Reagan.

This political reality makes the tax deal a bad bargain for Democrats. Think of it this way: The deal essentially sets up 2011-2012 to be a repeat of 2009-2010. Once again, there would be initial benefits from the stimulus, and decent growth a year before the election. But as the stimulus faded, growth would tend to stall — and this stall would, once again, come in the months leading up to the election, with seriously negative consequences for Mr. Obama and his party.

Maybe you don’t think this is a problem – you think that the incentives on the payroll tax cut run the other way, that it will be difficult to let the payroll tax cut expire, and the result will be more stimulus in 2011 and 2012.

That brings us right into the problem with the stability of the payroll tax and the long-run finances of Social Security. Dean Baker, who was initially supportive of the plan, turned against it today, because of this issue.

Effectively, this deal would give us a permanent two-percentage point reduction in the payroll tax in a Washington climate very hostile to Social Security.
The logic is that the tax cut is scheduled to expire in December of next year. While it would require new legislation to extend the cuts, the Republicans will describe the failure to extend the cuts as a tax increase on middle class workers. (Several Republicans have already told reporters that this would be their view.)

Democratic officeholders have had difficulty standing behind tax increases for the very richest people in the country. It is difficult to imagine them sticking their necks out for tax increases that will hit low and middle-income workers, especially in a context where unemployment is virtually certain to be above 8.0 percent and quite likely above 9.0 percent. This means that the reduction in Social Security taxes may not be for just one year, it may persist for the indefinite future.

In principle there is nothing wrong with financing a portion of Social Security benefits with money from general revenue. This was in fact the original intention of President Roosevelt when he designed the program. However, the fact is that the program has always been financed exclusively by the Social Security tax that is taken from workers’ wages. This makes the tax regressive, but it has the advantage that workers can quite legitimately say that they have paid for their benefits. This will be to some extent less true if a portion of the funding comes from general revenue rather than payroll taxes. In short, getting funding from general revenue opens a new line of attack on the program.

This is just one among the many problems with the structure of a payroll tax holiday. The hostage-taking on that will be no different than the hostage-taking on the Bush tax cuts. The goal would be to undermine Social Security and force long-term changes to the program. This has essentially been the Republican tax cut strategy forever – force artificial timelines and then get them extended out forever.

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David Dayen

David Dayen