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Payroll tax cut: It's not just for the middle class


President Obama and congressional Republicans remain mired in the preliminary scrimmaging over how to extend the Social Security payroll tax cut for another year.

The congressional leadership of both parties have committed themselves to passing the extension, so it seems likely to happen. But it’s not clear how it will happen, nor is it clear whether the loss of revenue would be offset by spending cuts or higher taxes on some people – or perhaps not offset at all.

Democrats say this push to extend and expand the payroll tax cut – to 3.1 percent on workers, instead of the normal 6.2 percent – is all about helping the middle class.

Rep. Steve Israel, D-N.Y, the chairman of the Democratic Congressional Campaign Committee said, “House Republicans are willing to leave for the holidays and force a $1,000 payroll tax increase on 160 million middle income Americans.”

But since the Social Security payroll tax is a flat 6.2 percent tax on earnings up to $106,800 (and up to $110,100 in 2012), Congress can’t give middle-class Americans a tax cut without also giving many upper-income or relatively wealthy earners a tax cut, too.

Of course “middle class” is a subjective term – a person earning $110,000 might consider himself middle class, although in some states Tennessee, for example, a $110,000 salary would be far more than twice the average annual salary for that area.

The national average for all salaries and wages paid in 2009 was $68,110, according to Internal Revenue Service data for the most recent year available, 2009.

Factoring in some wage growth in 2010 and 2011, what that means is that many people with above-average incomes have received this year’s payroll tax cut (and would continue to get one if Congress extends the payroll tax cut for another year).

In 2009, according to the IRS data, there were 10.3 million income tax returns with salaries and wages between $75,000 and $100,000; if you go up to the taxable maximum for the payroll tax, that would add tens of thousands more high earners who are getting a tax cut.

Roberton Williams, an analyst at the nonpartisan Tax Policy Center in Washington, said that “60 percent of an extended payroll tax cut would go to households making more than $100,000.”

If tax cuts for the middle class are what Congress wants, why not target a tax cut to those who are in the middle and not those at or above $100,000 in income?

Congress, in fact, did just that in the 2009 stimulus bill with a two-year, temporary tax break called Making Work Pay. Taxpayers were able to take a credit of $400 for singles and $800 for married couples filing jointly. The tax break was phased out for singles with incomes above $75,000 and for married couples with incomes above $150,000. So Congress didn’t give money to higher earners, as the payroll tax cut does.

Making Work Pay was modeled on the Earned Income Tax Credit for poor people as a way to offset to the payroll taxes they must pay. “The Making Work Pay tax credit was just an extension of that,” said Jason Fichtner, former chief economist at the Social Security Administration, who is now at the conservative-oriented Mercatus Center at George Mason University.

The payroll tax cut does have the virtue of being “immensely easier to administer” than Making Work Pay was, said Williams. Making Work Pay required filling out an extra line on the income tax return. “The IRS had extra work and the tax filer had extra work.”

But in a blog post, Williams makes a strong case that, instead of extending the payroll tax cut, Congress ought to revive and enlarge Making Work Pay, because it would “focus tax savings on low- and middle-income families, those most likely spend the extra money.”

The payroll tax cut worries some members of Congress in both parties who believe that it won’t be temporary – that Congress, next December and in the years to come, will find it very hard to raise the payroll tax rate back to where it was last year, 6.2 percent.

If Congress extends the tax cut, but cannot agree on offsetting revenue, then it will simply be borrowing money (and adding to future interest costs) to pay for the $187 billion tax break.

Donald Fuerst, a senior pension fellow at the non-partisan American Academy of Actuaries points out that this is the first time that Congress has changed the payroll tax rate in response to economic events.

Even in the recession of 1981-1982, when unemployment exceeded 10 percent for almost a year, Congress did not cut the Social Security tax.

In fact, it allowed an already scheduled Social Security tax increase to take effect, raising the tax rate from 5.08 percent on employees to 5.4 percent. If you include the Medicare part of the payroll tax, the total tax rate went from 6.13 percent to 6.7 percent – a tax increase on the “middle class” in the depths of a recession.

“If this were other than just a temporary change, it would truly be a fundamental change in how the system is financed, Fuerst said. “It’s been financed in the past almost exclusively with payroll taxes, and if this temporary change were extended, then a significant part of the funding would come from general revenues rather than the payroll tax –and that certainly is a fundamental change.”

He added, “We’re tinkering with funding here but not addressing the problems that exist… We’re using this as a tool to manage the economic conditions of today, but we’re not addressing the long-term problems that Social Security has.”