Payroll Tax Cut Extension Could Bring Economic Benefits

Not extending the cut, say economists, could further threaten a shaky economy.

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It looks like a political battle that the president just might win. Back from Thanksgiving break, congressional Democrats are looking to extend the year-old cut in the payroll tax, which is paid by both workers and employers. Insiders are saying it's a potential area for bipartisan agreement. Political winner or not, many economists say that the tax cut provides clear economic benefits, especially when compared to the alternative.

The tax cut is set to expire on December 31. Senate Democrats are pushing an extension, that would further trim this tax, once levied at a rate of 6.2 percent but trimmed a year ago to 4.2 percent, to 3.1 percent. The plan would also cut the tax paid by employers on the first $5 million of their payrolls. The tax cut is currently worth an estimated $934 to the average family, according to the Center for Budget and Policy Priorities.

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Macroeconomic Advisers has estimated that the expiration of the tax cuts could reduce GDP growth by a half a percentage point and cost the economy 400,000 jobs by the fourth quarter of 2012. And dollar for dollar, keeping the temporary payroll tax cut into 2012 would boost the economy more than other tax cuts, like making the Bush tax cuts permanent or cutting the corporate tax rate, as Mark Zandi, chief economist at Moody's Analytics, has shown.

The potential downsides to the extension are minimal compared to the economic stimulus that they provide, according to Chuck Marr, director of federal tax policy at the Center for Budget and Policy Priorities. "I think the risks are on the other side. There is the risk that it would expire and it would be a negative event. Every paycheck in the country would go down on January 1," he says.

Yet keeping the tax cut is not without cost. The holiday enacted one year ago cut Social Security payroll taxes from 6.2 to 4.2 percent, meaning there is less money being collected to fund the already endangered Social Security system.

Repeatedly extending the holiday could be problematic, acknowledges Marr. "Certainly if it became commonplace you'd have to worry about Social Security," he says, adding that "Social Security is going to need more taxes, not less." But risking further economic problems is too great a price to pay, he believes, compared to the hit that Social Security would take from two years of payroll tax cuts.

Providing an extra $1,000 per year to many American families will also mean taking money from somewhere else—in this case, wealthy Americans. To pay for the extension, Democrats have proposed a 3.25 percent tax surcharge on income topping $1 million. Such proposals have repeatedly met with opposition from Republicans in Congress.

Grover Norquist, the president of anti-tax group Americans for Tax Reform, says that however Congress chooses to offset the tax cut, lawmakers should be careful to ensure that they do not further hurt the economy. "If you are continuing [the tax cut] and raise some other tax, then you'd have to make a judgment call on whether the tax you raise did more damage to the economy than the one you are cutting."

However, the benefits of such a tax cut may far outweigh the effects of a tax on millionaires. The top earners tend to spend much smaller percentages of their disposable income than working- or middle-class people, who often live paycheck-to-paycheck and are more likely to spend extra money in their pockets.

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Still others disagree with the notion of whether the tax cuts have been effective. Arizona Sen. Jon Kyl said in a television interview this weekend that the holiday has been a failure. "The payroll tax holiday has not stimulated job creation. We don't think that is a good way to do it," he said, arguing that taxing the richest Americans means taxing America's job providers.

While Republicans may create a united front opposing some aspects of Democrats' proposal, Norquist offers only tepid disapproval. "It's not the dumbest thing Obama's ever done," he says, adding, "It's the one part of the jobs act that isn't actively destructive."