Middle Class Taxes Just Went Up

The vaunted middle class isn't as sacrosanct as politicans make it sound.

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Reporters surround Assistant Majority Leader Sen. Richard Durbin, D-Ill., outside the Senate chamber during negotiations on the fiscal cliff.

The headline news from the recent deal to avert the fiscal cliff is that Congress is raising tax rates on wealthy individuals for the first time in nearly two decades. Less noticed is something that may be equally momentous: Congress just raised taxes on the middle class as well.

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The New Year's Day accord makes permanent tax rates that were scheduled to rise on 99 percent of Americans, sidestepping a huge tax hike for most Americans. The one exception is a higher tax rate on couples who earn $450,000 or more ($400,000 for individuals), which more or less fulfills President Barack Obama's pledge to raise taxes on the wealthy.

But virtually every worker will still get a smaller paycheck in 2013, because of another tax measure that expired. Beginning in 2009, Congress cut the payroll tax—which helps finance Social Security—to put a bit of extra spending money in workers' pockets. The law was changed and extended, with the latest version cutting the tax from 6.2 percent of income to 4.2 percent. Congress has now allowed it to lapse for good.

So in 2013, the rate will rise back to 6.2 percent and most workers will have an additional two percentage points of their income automatically deducted from their paychecks. It's easy for anybody to figure out how this will affect them—just calculate 2 percent of your gross pay, up to the 2013 limit of $113,700. For the typical worker earning about $50,000, the reversion to 6.2 percent will cost about $80 per month, or $1,000 per year. The most it could cost anybody is about $2,300.

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Whether this amounts to a "tax raise" is a matter of semantics, of course. Obama and all the other politicians in Washington are sure to insist that it's not a tax hike, because it was scheduled to happen anyway. And since the original tax cut was labeled temporary in the first place, it shouldn't be a surprise that it has expired as promised.

But it's notoriously difficult to roll back any tax cut, no matter how it's labeled, which is why some politicians push for "temporary" tax cuts knowing full well that they may never be allowed to expire. That was the logic behind the 2001 and 2003 Bush tax cuts, which were supposed to expire at the end of 2010, but were extended for two years and are now effectively permanent, with the exception of the new top bracket.

So letting a middle-class tax cut expire is an unusual move, and the fact that Obama and Congress allowed it to happen gives some clues about the financial crunch Washington still faces.

First of all, the payroll tax funds Social Security, which already requires some modest changes to keep the program solvent, such as a higher retirement age at which seniors start to receive benefits. Since Social Security is popular, there was bipartisan agreement to let the payroll tax cut lapse, and restore the full flow of money to the pension program for seniors.

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Second, nearly everybody in Washington knows that the deal to avert the fiscal cliff does practically nothing to fix the government's spending-revenue mismatch or to begin closing huge annual deficits. So pulling in a bit more revenue at least keeps the problem from getting even worse—and it does so before the payroll tax cut starts to feel permanent, and harder to roll back.

Perhaps most importantly, reverting to the higher payroll withholding signals that the middle class isn't as sacrosanct as Obama and other politicians want to make it seem. Obama, of course, has vowed not to raise middle-class taxes, but he also knows that there's no way to truly solve the big budget issues without doing so. That's the conclusion of nearly every credible expert who has examined the problem.

The 2010 Bowles-Simpson commission—which Obama chartered—called for a range of tax increases that would hit every income bracket and cost the average household about $1,700 in new taxes on income. That report is considered a realistic gauge of what it would take to stabilize government spending and get Washington's annual deficits under control.

It's possible that Obama can serve another four years before the debt problem becomes so acute that it's imperative to raise middle-class taxes. So he may be able to serve two terms and say he fulfilled that campaign pledge. But doing so might make the whole debt problem far worse and weaken the economy much more than necessary. The middle-class folks Obama seeks to protect might end up better off if he broke that promise sometime soon.

Rick Newman is the author of Rebounders: How Winners Pivot From Setback To Success. Follow him on Twitter: @rickjnewman.