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Payroll Tax Cut Will Expire Because of Its Relationship to the Social Security Trust Fund

It’s been pretty clear for a while that the payroll tax cut would not be making a return appearance in 2013. Nancy Pelosi basically confirmed this last week, but you could actually see this coming as far back as June. So Annie Lowrey’s eulogy for the payroll tax cut really plays catch-up more than anything.

Regardless of who wins the presidential election in November or what compromises Congress strikes in the lame-duck session to keep the economy from automatic tax increases and spending cuts, 160 million American wage earners will probably see their tax bills jump after Jan. 1.

That is when the temporary payroll tax holiday ends. Its expiration means less income in families’ pocketbooks — the tax increase would be about $95 billion in 2013 alone — at a time when the economy is little better than it was when the White House reached a deal on the tax break last year.

Independent analysts say that the expiration of the tax cut could shave as much as a percentage point off economic output in 2013, and cost the economy as many as one million jobs. That is because the typical American family had $1,000 in additional income from the lower tax.

The numbers I see for the payroll tax cut range as high as $120 billion. But the result is pretty much the same; 1% of GDP reduction in 2013, because nobody wants to extend what amounts to a 2% wage subsidy on the first $110,000 of income. Matt Yglesias is in despair.

A lot of this has to do with the manner in which the payroll tax cut was administered. Republicans are opposed to the payroll tax cut because it was a Democratic idea, but they could get whipped into shape, as they did at the beginning of this year, if Democrats harped on the “tax cut” aspect of it. The reason Democrats won’t is because of the impact on the Social Security Trust Fund. The payroll tax cut takes money that would go to that Trust Fund and distributes it to workers. Then the General Fund pays back the Trust Fund.

And this has worked; the Trust Fund indeed has been paid back. But the rhetorical threat of attacks to Social Security based on a strain on the actual budget has been too much for Democrats to bear. They have a good argument to make about how Social Security doesn’t affect the budget, and the mechanism of the payroll tax cut undermines that.

The solution to this was not to play this game at all. There are 100 different ways to design a wage subsidy that does not implicate the Social Security Trust Fund. In fact, the first two years of the Obama Administration used one of them, the “Making Work Pay” tax cut, which was a refundable tax giveback of $400 for individual workers up to a certain level. In fact, that tax cut did a better job of getting to workers at the low end; it was a more progressive tax cut. Low-wage workers actually did better under Making Work Pay than the payroll tax cut.

One argument was that Making Work Pay only had half as much impact as the payroll tax cut. The answer? Double Making Work Pay. Another objection was that Republicans had it out for Making Work Pay and wouldn’t extend it beyond 2010. Again, you could design a tax cut that Republicans would be hard-pressed to pass up about a hundred different ways. The key is that implicating the payroll tax made it unsustainable over the long term because it cut off support on the left.

As a result, we’re headed into the 2013 age of austerity by pulling back on fiscal support when it’s unclear the economy can stand on its own.

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David Dayen

David Dayen