One of the most troubling aspects of the current tax debate has been that policymakers have almost completely ignored the about-to-expire payroll tax cut. Not any more: President Obama has called for a one-year extension of the payroll tax cut or enactment of a similar-sized tax cut for working families, according to press reports.
This is very good news for the economy and for the paycheck of every working American.
The payroll tax cut was designed to put more money in the pockets of average Americans, particularly those who tend to live paycheck to paycheck and, hence, would spend it soon, boosting the recovery.
The table gives some examples of its effect. If we let it expire, every paycheck in America will go down the first week of January. And that will slow the recovery.
The impact would be sizable: Goldman Sachs estimates that letting the payroll tax cut expire would slow next year's economic growth rate by 0.6 percent. Slower growth, in turn, would put upward pressure on unemployment.
In contrast, letting the high-end Bush tax cuts expire, as the President has proposed but congressional Republican leaders have rejected, would slow next year's growth by a negligible 0.1 percent, according to the Congressional Budget Office.
Clearly, the economy would be far better off in both the short and long term if we temporarily extended the payroll tax cut (or enacted an equivalent tax cut aimed at working families) but let the high-end tax cuts expire:
- The payroll tax cut would help support the economy next year, offsetting many times over the short-term impact of letting the high-end tax cuts expire.
- The expiration of the high-end tax cuts would lock in about $1 trillion in deficit reduction over the next ten years. That would boost national savings, promoting long-term economic growth.
Because payroll tax receipts go into the Social Security trust funds, some are understandably wary of extending the payroll tax cut. But offsetting contributions to the trust funds from general revenues have held the trust funds harmless from the reduction in payroll taxes.
This arrangement doesn't pose a danger as long as it remains strictly temporary. The greater risk is the economic damage that an abrupt expiration of the payroll tax would cause.
Ideally, budget negotiators would replace the payroll tax cut with an equivalent temporary tax cut carried out through the income tax, along the lines of the 2009 Recovery Act's Making Work Pay tax credit. If this isn't possible, they should extend the payroll tax cut.