Democrats’ Big Payroll Tax Cut Gamble

If this year’s payroll tax cut is extended — and possibly expanded — for another year, it will prevent the economy from taking a significant hit at a time when demand is weak and unemployment remains unacceptably high.

That’s the good news.The bad news is that at some point — most likely the end of 2012 — the payroll tax holiday will have to expire. Democrats have a strategy for allowing the holiday to end without dramatically and abruptly imposing an effective tax increase on the middle class. But it’s based on a big gamble — that over the course of the next year they’ll break the GOP’s resolve and win a generational fight with the conservative movement over raising taxes on the rich.

At a Capitol press conference Wednesday, TPM asked Senate Majority Leader Harry Reid (D-NV) how Congress would ultimately allow the payroll holiday to lapse next year. The current cut is 2 percent. Democrats want to bring it down further to 3.1 percent. Either way, it’s a significant amount of money for the middle class workers who provide the lion’s share of payroll tax revenue — and that money will be set to come right back out of their paychecks when the plan expires.

Reid noted cryptically that the expiration of the payroll holiday will be of less budgetary significance than the expiration of the Bush tax cuts — particularly the Bush tax cuts for the rich — which will both expire on January 1, 2013, if the payroll cut is extended.

What he meant, according to a top Dem aide, is that Democrats hope to use the leverage they have over Republicans, because of the expiring Bush tax cuts, to force a broad tax reform — one that lowers rates on the middle class enough to make up for the expiring payroll holiday, but that still raises a significant amount of revenue from higher income workers.

“A year from now you have the Bush tax cuts expiring, which will hopefully force Republicans to negotiate a tax reform. The outcome could be that rates go down, such that the middle class can get an income tax cut that offsets the payroll tax expiring,” the aide said.

At a briefing with reporters at the Eisenhower Executive Office Building this week, senior White House officials made the same argument.

To facilitate the expiration of the payroll tax cut, one official said, “I think what you would do is you engage in a tax reform process that would simplify the tax code and be able to broaden the base and deal with rates for everyone…. You can’t do it if the price for doing it as the Republicans suggested in the Super Committee talks was permanent extension of the Bush tax cuts for the wealthy. That’s a non-starter.”

The administration also believes that the expiring Bush tax cuts, along with the automatic spending cuts triggered by the failure of the Super Committee, will force Congress to deal with this on terms favorable to Democrats. But that will require Republicans to abandon their iron commitment to never raising taxes on anybody, particularly the rich.

And there’s no backstop here. Every payroll tax holiday under consideration expires completely, all at once — no phase out. And if Congress fails to address the overall tax code next year, and fails to pass deficit reducing legislation that can replace the automatic cuts, then a giant austerity bomb will go off on January 1, 2013 — including higher payroll and income taxes for the middle class.

Ever since the payroll tax cut passed last year, some progressives in Congress and off of Capitol Hill have warned that allowing it to expire will be politically very difficult. Crucially, the payroll tax funds Social Security. And though the current payroll tax cut, and the one likely to be enacted next year, make up for the lost revenue by requiring the trust fund to draw out of the general fund, they worry that this might not always be the case, and that if the payroll tax cut becomes a quasi-permanent policy (like the Bush tax cuts) it will ultimately begin to eat away at Social Security’s solvency.

So the stakes are quite high, both for the economy and, potentially, for the social safety net. This is one of many important reasons why 2012 will be an unusually busy legislative year, despite the presidential election.

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