For the past 12 months, payroll taxes for working Americans have been reduced by 2 percentage points, putting about $1,000 extra in the pocket of typical household. If Congress does not act by year's end, the full payroll tax of 6.2 percent will be restored to everyone's paychecks, increasing taxes on 160 million Americans.
Extending the cut won't do much to help the economy in terms of creating jobs (there's no saving for employers) or spurring spending (in this economy, people are more likely to use marginal increases in take-home pay to pay down debt than to go shopping).
As importantly, extending the cut on a temporary basis is precisely the sort of half-baked intervention that accomplishes little more than injecting even more uncertainty into an already murky economic situation. Reducing tax rates can help spur investment and job creation, but "temporary" tax cuts never have that effect precisely because producers and consumers know a change is coming soon.
Making the payroll tax cut permanent is a different story, but only if Social Security benefits are cut by the same amount as the reduction in taxes. Remember, in theory, taxes are credited to the Social Security Trust Fund, where they establish the program's authority to pay out benefits to retirees.
Unfortunately, Congress will likely be politically expedient and cut taxes without cutting benefits. To pull this off, policymakers will borrow money and transfer it to the Social Security Trust Fund to make it look as if this tax revenue was collected. Make no mistake: That's just another unfunded promise to seniors that will be paid for by future's generations.
This isn't new practice, of course. This budget gimmick was already used to "pay" for the $120 billion revenue shortfall from the December tax deal. Also, for years, we have been recording tax revenues from the beneficiaries of the earned income tax credit (EITC) even though their share of the payroll tax is refunded to them. Also, the Making Work Pay tax credit that was part of the stimulus bill also refunded payroll taxes a second time over to many of these same workers.
The good news is that this should expose the fiction that Social Security benefits are fully backed by payroll-tax contributions, and hence, can't be reformed. Social Security is already running a cash-flow deficit, meaning there is not enough money to pay retirees' benefits. With the payroll tax cut extension adding to the program's financial difficulties, it may be the impetus for Congress to pursue fundamental entitlement reform and address the underlying drivers of our debt problem.
About Veronique de Rugy Senior Research Fellow at the Mercatus Center at George Mason University