Payroll Tax Cut Extension May Not Pass – A Bad idea May Be Put to Rest

More Evidence of the Tenet – If Bad Policy Can be Adopted, It Will Be Adopted

At the end of 2010 the Obama administration proposed cutting 2 percentage points on the SS Payroll tax that employees pay.  It is not clear what the motivation was for this particular policy, it was certainly not great economics.  The Administration may have felt that this was the only stimulative type of program they could get enacted.

Anyway, the tax cut was passed for one year, which made a bad idea even worse.  The tax cut itself was unlikely to translate into increased economic demand; some taxpayers used the extra money to reduce debt and save more and others, knowing the tax cut was temporary did not change their spending.

Although the Treasury replaced the lost money by making an injection in the SS Trust Fund, the implication out there was that the policy might weaken the Trust Fund, and produce an even greater shortfall in funding future SS benefits.  Politicians, being what they are (don’t ask) would use the fear of loss of SS benefits to instill even greater fear in the public and the elderly.

Now the end of 2011 is coming it looks like Congress may not be able to pass an extension of the tax cut.  The weakness of the policy is proving its undoing.  Republicans are opposed because the tax cut does not benefit their natural constituency, the wealthy and because they are suddenly concerned about the deficit and about the possible implications for Social Security.  Some Democrats are also reluctant to support the policy.

If the payroll tax cut is not extended there will be an increase in middle income taxes for 2012 as compared to 2011.  For the same reasons that the reduction in payroll taxes did not help the economy, this increase will not have a major impact on reducing economic growth.  But it will have some impact, and the psychological effect may be greater than the economic effect.  If employees feel poorer because of the publicity they may cut spending even more. 

So it may be that when the history of this period is written the policy of temporary cutting payroll taxes is the worth of both worlds.  It did little or nothing to stimulate the economy when enacted, but was harmful when it was allowed to expire.  Only Washington can come up with such a policy.