Payroll Tax Deal-What Does It Cost?

Listening to the talking heads legislators in D.C. over the past few days confirms to me that a deal on extending the payroll tax cuts for another year is going to get done. Sure there will be some histrionics, but there will be no tax increase for American workers come January 1, 2012.

This is a far cry from what Obama asked for a few months ago. He will have to be happy to get this. The extension will reduce tax receipts by about $120b for 2012. The deficit will go up accordingly. The economy will benefit. I estimate that the extension will add about 1.5% to GDP. This should give us a shot at achieving 2%+ growth. Absent the extension, the economy would clearly have hit stall speed with growth under 1%.

Republican Senator Dean Heller (R-Nev.) has put up a Bill that tweaks things to suit the Republicans. I think there are some provisions in this Bill that the Democrats will like. There are other items that the Democrats will not like.

The Bill does provide for a Buffet Tax. This would be a 3.25% surcharge on incomes over $1mm. In the scheme of things, this does not raise much revenue ($20b a year?), but it’s appealing to voters. It’s all about the optics.

There is a provision to limit the availability of unemployment insurance for high-income workers. That sounds good too. But the numbers are a joke. The tax on unemployment benefits is equal to 100% on individuals who had income greater than $750,000 in the prior year ($1.5mm household). Make what you will of this. My take is that there is not much “austerity” in these limits.

One element of the proposed legislation got a chuckle from me:

PART IX — DONATIONS TO PAY DOWN NATIONAL DEBT

The deep thinkers are putting into law the terms under which one could make a donation to the government with a designation that it be used to reduce the federal debt.

A law is required for this to establish that the donations are (of course) tax deductible. (Only in America.) I hope the Feds never collect a dime from this. If one had some extra bucks in his pocket, was feeling generous and looking for a tax break, there are an endless number of better alternatives than giving the dough to Uncle Sam. I think this is a dopey idea.

The legislation pays for the 2012 tax breaks buy cutting further the discretionary spending limits that were establish as part of the Super Committee failure.

The numbers in Heller’s legislation are worth considering. The first thing that jumps out at me is that the spending limits from 2013-2021 still total a thumping $10 Trillion. Second, the rate of growth of discretionary spending will fall to a miserly 1.8%.

To get the long-term fiscal picture back to being sustainable, a slow down in expenditure is necessary. The proposed legislation tries to achieve that. However, this long running cap on spending will translate to an equally long-term period of sub 3% economic growth. I wouldn’t be surprised it the GDP gains matched the growth in expenditures in the future. That would mean GDP averages about 1.8% for the next eight years or so.

If 1.8% GDP for the next eight years were the outcome, it would be a disaster. The non-discretionary side of the budget will explode regardless of economic performance. If GDP does not rise by a minimum of 3% (average), tax receipts will fall well below plan, and the budget will explode on its own. We will be at 200% debt to GDP by 2021 if sub 2% growth is in our future. We either grow or die; but, we can’t grow without bigger deficits and more debt. What do you call this? Dilemma comes to mind. Alternatives include, quandary, tight spot, predicament, impasse or catch-22. A problem, is what it is.

I look at the proposal to extend a 2% tax break to workers for a year, in exchange for what will feel like a very big tax increase in 2013, as a dangerous plan. Yes, it might help for another 12 months. However, we are going to hear (again) that great sucking noise as the tax increases (coupled with the budget limits) come into effect in 2013.

Note: There will be a bunch of additional to-ing and fro-ing on this. It will go close to the Holiday recess. It will be interesting to see how much pork is attached to this Bill in order to get the needed votes. My guess it this will be loaded with payoffs. So much for that austerity thing….

• Become A Funded Futures Trader