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The Forgotten Payroll Tax Cut and the Fiscal Cliff

Though Congress has decided to slink out of Washington early, there is one meeting of some importance going on in Washington this week. The House Ways and Means Committee, the main tax-writing body, will meet in a bipartisan closed session tomorrow to go over the spate of expiring tax measures that hit at the end of the year.

It’s the biggest issue facing Congress right now: the Dec. 31 expiration of all income tax rates, unemployment benefits and the payroll tax holiday. Ways and Means – chaired by Michigan Rep. Dave Camp – is ground zero for this fight.

The meeting’s agenda, as described by several sources, is broad and focuses on outstanding committee business.

There’s no guarantee that the payroll tax cut will factor into these negotiations, but they should – or at least something that brings a commensurate level of fiscal accommodation, which preferably doesn’t put the Social Security Trust Fund at risk. The expiration of the payroll tax cut will take $125 billion out of the economy. That’s less than the Bush tax cuts, although since most of those accrue to the rich, the payroll tax cut could have a higher fiscal multiplier. And it’s a larger pullback in fiscal policy than the first year of the sequester, which would take roughly $110 billion out of the economy.

Members of both parties don’t want to see the payroll tax cut extended. It has mostly fallen off the radar of the fiscal cliff negotiations. But understand this means that fiscal policy will snap back in 2013. Most working people will see less from their paychecks. There are ways to deliver the same kind of effect to the economy without imperiling the Social Security Trust Fund – like with the Making Work Pay tax cut of 2009 and 2010, for example, which in 2008 the Obama campaign ran on as a permanent condition.

I would like to find the economist who believes that the US can handle taking $125 billion out of the economy without an effect, especially $125 billion targeted loosely (though not as well as Making Work Pay) at those with a high propensity to spend. To take one example, defense spending, which often goes toward bloated contractor payouts, could do with some cuts, and the sequestration could be handled without laying off troops or even canceling core weapons programs. The Bush tax cuts, mostly focused on the wealthy, target those with a lower propensity to spend. If you think the economy remains fragile and unable to fill the gap in demand from the Great Recession, the three programs set to expire that you would want to see extended are the payroll tax cut, extended unemployment insurance and a voiding of the sequester on discretionary spending. It does not surprise me that those are the three programs most likely to expire at the end of the year.

It’s entirely possible that everything gets punted for a period of time while opening up some breathing space for Congress to figure the mess out. But I doubt that includes the payroll tax cut. That’s decent enough news for Social Security, but it’s not really good news for the economy.

As a postscript, you gotta love this from a defense lobbyist:

“Regardless of who wins, the big deal will have tax increases and spending cuts,” said one defense lobbyist, who asked not to be identified. “The ratio will just be different. With taxes playing a smaller role in a Republican plan, entitlement programs like Medicare will have to play a bigger one to protect defense.”

Surely we can all agree that Lockheed Martin needs the money more than an 85 year-old on a fixed income.

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David Dayen

David Dayen