Payroll Tax Cut Set to Expire at the End of 2012

Millions of Americans may be taking home a few less dollars next year, as a major tax cut may soon disappear.

The payroll tax break, first enacted in 2010 by Congress in an effort to give wage-earners more cash in their pockets during a sluggish economy, is set to expire at the end of December. More than 122 million people will be affected.

This tax, which is used to fund Social Security, was temporarily reduced to 4.2 percent from 6.2 percent, with the intention of aiding struggling families during hard times. According to the independent Tax Policy Center, working families on average took home an extra $934 per year as a result of this payroll tax break.

The temporary tax cut, which is worth 2 percent of the first $110,100 of one’s wages, was then extended into 2012, costing the federal government about $120 billion in tax revenue this year. Money was diverted from general funds to make up for the shortfall to the Social Security Trust Fund. The lost tax revenue was never replaced with tax increases or cuts in spending, so the lost payroll tax was added to the federal deficit.

Debating the Tax Break

There has been an ongoing debate over the years between Republicans and Democrats regarding the effectiveness and possible long-term effects of the payroll tax break.

Supporters of the payroll tax break point out that the 2 percent decrease in tax gives the average worker approximately $35 per week. This extra cash in hand would in turn boost the economy when it was spent, whether the money was used to fill up the gas tank or to pay for a night out at the movies.

The resulting increase in consumer spending, supporters say, could assist in stimulating the economy which, in turn, could possibly give employers the revenue they need to hire more people.

Those opposed to the payroll tax break say the concept of reducing the tax is not an effective economic stimulus. There isn’t any proof, they have warned, that the increase in spending has significantly helped the unemployment rate so far.

Economist Stephen Entin at the Institute for Research on the Economics of Taxation, for example, said borrowing money or taxing someone else to generate funds to pay out isn’t a good strategy. He compared the process to playing musical chairs with money — as it’s merely moving cash around from one group to another.

Opposition to the Tax Break

Those economists who oppose the tax break are said to be mostly concerned about the possible risks involved in withholding money from Social Security. Underfunding the Social Security Trust Fund can affect the benefits of millions of Americans and their families in the future.

Rep. David Camp, R-Mich., who heads the House Ways and Means Committee overseeing tax policy, said he doesn’t believe the United States can keep cutting into Social Security.

Senate Democratic leaders are said to be interested in letting the payroll tax break expire if another tax deal could be created to prevent the tax burden from falling on middle-class families.

As the deadline for the payroll tax cut expiration looms, it isn’t clear whether it will be renewed for the 2013 tax year. White House spokesman Jay Carney has said the administration will evaluate the strength of the economy as the end of the year draws closer and will make a decision whether the break is necessary.

According to Capital Economics, an independent macroeconomic research consultancy, elimination of the payroll tax break could affect real economic growth by up to half a percentage point in 2013.

If the payroll tax break is allowed to expire as scheduled, those workers who once qualified for the break will see their paycheck reduced by 2 percent starting in January.