WASHINGTON – Wage earners have been surprised to rip open their first pay envelope of 2013 to discover their check provides less take-home money than anticipated – especially after being told the middle class was protected in the fiscal cliff agreement.
The reason is the big issue that both Democratic and Republican negotiators pointedly ignored during the seemingly endless balanced budget talks – the expiration of the two-year payroll tax holiday.
Beginning on Jan. 1 the payroll tax, also known as the Federal Insurance Contributions Act (FICA) tax, which is used to fund the Social Security system, jumped from 4.2 percent to 6.2 percent. Most of the estimated 160 million Americans who pay into the system will therefore see their anticipated income drop by 2 percent.
And there’s no reason to believe the money will be restored anytime soon. The reason, according to Donald Marron, director of the Washington-based Tax Policy Center, is simple – it “was always intended as a temporary tax cut to provide stimulus to the economy.”
As early as last February Treasury Secretary Tim Geithner indicated he would not recommend another extension of the cut that was first put into place in 2011.
“This has to be a temporary tax cut,” Geithner said in testimony before the Senate Budget Committee. “I don’t see any reason to consider supporting its extension.”
Heavy legislative hitters like House Democratic Leader Nancy Pelosi, of California, and Rep. Paul Ryan (R-Wis.), chairman of the House Budget Committee and his party’s 2012 candidate for vice president, likewise expressed a preference for letting it expire. Neither President Obama nor GOP presidential nominee Mitt Romney proposed an extension during the recently completed campaign.
The payroll tax holiday proved very expensive, reducing federal revenues by about $9 billion a month. While the Social Security system itself wasn’t affected – general revenues were used to compensate for the lost payroll tax monies — it had a harsh impact on a U.S. Treasury that was already rolling up deficits. The holiday cost was an estimated $103 billion in 2011 and $112 billion in 2012.
“It was viewed as a temporary holiday, put in place for one year and extended for another but never meant to be permanent,” said Sen. Rob Portman (R-Ohio), director of the Office of Management and Budget for more than a year under former President George W. Bush. “It didn’t create a problem for the Social Security system in the sense that we needed to put general revenues into Social Security because there were fewer payroll taxes going into the Social Security trust fund.
“It was one of these things that on a temporary basis it was appropriate but over time it makes it more difficult to increase the solvency of Social Security on its own, which is kind of the goal on both sides of the aisle,” Portman told PJM. “And then, finally, there’s just the overall deficit problem. Coming out of general revenues makes it more difficult to get that under control.”
Portman said he doesn’t anticipate any effort to reinstate the holiday.
The FICA tax assesses a 12.4 percent tax on earned wages up to $113,700. It is split evenly between worker and employer, each picking up half the tab, or 6.2 percent.
Under the Tax Relief Unemployment Insurance and Job Creation Act of 2010, the worker’s share was reduced to 4.2 percent in 2011 in an effort to provide a boost to a sluggish economy, the thought being that taxpayers would use the extra take-home pay to purchase goods, thus acting as a stimulus by circulating money through the system. That provision was then extended for an additional year.
In 2012, about 75 percent of the nation’s tax units brought home an additional $770 on average as a result of the payroll tax holiday. A study by the Tax Policy Center found that the 2 percent increase will have the greatest impact on lower- and middle-income taxpayers.