Paying for the Payroll Tax Cut

Late next week, Congress will extend the present law 2% payroll tax cut for another year. This is a good way to sustain our fragile economic recovery. The additional take home pay each pay period is more likely to be spent than a lump sum would. How it’s paid for matters too. Rather than borrowing another $120 billion from China and $35 billion to extend unemployment insurance and $38.9 billion to avoid slashing the Medicare physician reimbursement rate by 27%, several items previously agreed to, but never proposed by the Super Committee, will almost pay for them over the next decade. This afternoon, the Congressional Budget Office scored the House Republican version of the payroll tax cut, H.R.3630. It’s $25.2 billion short of balance FY12-FY21. It starts out with a deficit increase of $166.8 billion in FY12, $71.6 billion in FY13, and $9.3 billion FY14, a total of $247.7 billion (assuming it’s not extended late next year), before reducing the deficit by $222.5 billion over the rest of the decade.

The pay fors in order of size are: Medicare spending cuts, $38.4 billion; increased federal employee retirement contributions, $36.7 billion; increased Fannie Mae and Freddie Mac mortgage insurance rates, $35.7 billion; other health care offsets, such as cuts in the PPACA prevention fund, $33.4 billion; FCC spectrum auction, $16.5 billion; and other, $36.6 billion.

Aside from the recession driving down revenues and raising unemployment insurance and other federal benefits, rising health care costs, mostly in Medicare and Medicaid, have been the largest drivers of our rising deficit, so it makes sense to look there for spending cuts and revenue increases. Federal employees will pay more for their pensions. I don’t know how generous those pensions are projected to be in comparison to contributions. Anybody? Certainly, under-priced Fannie Mae and Freddie Mac mortgage insurance was a big contributor to the real estate bubble that preceded our recession, so this pay for makes a lot of sense. Health care spending will be a battleground for a long time. How much cost savings would have resulted from the PPACA prevention fund? I don’t know, so this one depends on how effective or ineffective that spending would have been. We probably will never know. I don’t object to assuming some revenue from FCC spectrum auction, but I would note that past FCC spectrum auctions have failed to deliver projected revenues.

The Senate Democratic payroll tax cut, S.1944, would expand the current 2% cut to 3.1% and would pay for it with a 10-year 1.9% surtax on incomes over $1 million. CBO scored this as balanced. It doesn’t include the unemployment insurance extension or the “doc fix” or the alternative minimum tax relief in the House Republican bill. While I am concerned about the burgeoning income disparities in this country, I would rather set income tax rates as part of a broad reform we desperately need and not as an ad-hoc increase on millionaires to pay for a one-time tax cut.

I expect the final version of this bill to look similar to H.R.3630. If President Obama signs it before Christmas, employers will have to scramble to implement it in time for the first paychecks of the new year. Washington’s last-minute-itis strikes again.

About Pete Davis 99 Articles

Affiliation: Davis Capital Investment Ideas

Pete Davis advises Wall Street money managers on Washington policy developments that affect the financial markets. President of his own consulting firm since 1992, Davis Capital Investment Ideas, he draws on 11 years of experience as a Capitol Hill economist with the Joint Committee on Taxation (1974-1981), the Senate Budget Committee (1981-1983), and Senator Robert C. Byrd (1992). He worked in the House and Senate, and for Republicans and Democrats.

Davis brought the first computer policy model, the Treasury Individual Income Tax Model, to Capitol Hill in early 1974, when he became a revenue estimator on the Joint Committee on Taxation. He formulated the 1975 rebate, the earned income tax credit, the 1976 estate tax rates, the 1978 marginal tax rates, and the Roth-Kemp tax cut. He left Capitol Hill in 1983 for the Washington Research Office of Prudential-Bache Securities, where he advised investors for seven years.

Davis has long written a newsletter on the Washington-Wall Street connection for his clients; Capital Gains and Games is his first foray into the blogosphere.

Visit: Capital Gains and Games

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