Payroll Tax Reduction Expiration: Stepchild in the Room

The fiscal cliff is the dreaded phrase of the time. Unless you can not read, ever watch or read news or have devoted your life to only following football, the fiscal cliff is a combination of the expiration of about 140 federal income tax provisions and the first installment of the budget sequester which mandated a reduction of budget authority for some defense and domestic social programs. This will all happen in less than about 4 months unless changed by Congress which will spend most of that time in recess.

The biggest tax increase will be the reversion to pre-2001 tax rates and levels for all taxpayers enacted during the Bush Administration. If current income tax rates are allowed to expire, every taxpayer will pay more taxes and perhaps even a few non-taxpayers will start to pay some modicum and token taxes. There are so many other nuances involved besides the actual marginal rate, like the marriage penalty, reduced rates on investment income and investment write-offs. In addition there is that nasty Alternative Minimum Tax (AMT)

However, there is a subject that should be mentioned and one, if not acted upon, will impact everyone by increasing taxes for all no matter what happens on the rates. It is the two percent reduction in employee payroll taxes first effective in 2011. I do not hear any of the candidates nor anyone in Congress bring this stepchild up for discussion.

 I saw a political commercial over the weekend in which the election of Mitt Romney was going to raise the taxes of every middle class American by $2,000. Where that figure comes from-except out of non-existent air- I have no clue. Mr. Romney has laid out some general tax parameters but nothing specific enough to make that kind of charge. On the other hand Mr. Obama just harps on about raising taxes of the wealthy and not much else. 

 Well guys, let’s bring up an elephant in the room. An employee’s wages are subject to the 12.4% Social Security tax up to the annual wage ceiling. Higher-incomes get socked with even high employment taxes for Medicare.  Half the Social Security tax bill (equal to 6.2%) is withheld from employee paychecks while the employer pays the other half. Social Security taxes are a major tax hit. If you made  $100,00 (slightly below the wage base) Social Security taxes were before 2011, $12,400 (12.4% x $100,000) split between the earner and the employer.

For the last two years, there has been a two percent reduction in the employee portion with the employer’s rate unchanged. This mean our beloved taxpayer making 100 K has been getting in this example a $2,000 reduction in his overall tax bill. Whoa, can that be the same $2,000, which Mr. Obama speaks? If so, he is equally as guilty of the charge. 

Here is the other problem, continuation of the reduction will add to the federal deficit by $120 billion a year. I never get weary of saying the federal deficit increases $4 billion dollars a day, now past $16 trillion and keeps on ticking. Before the next President completes his first year in office, it will be $17 trillion, no doubt.

The point of all of this is the fiscal and economic health of the country, the integrity of the tax system and ability of the country to try to inch anywhere even in the direction towards budgetary sanity is a complexed mix of issues, all inter-related.

Ending the employee payroll tax reduction will have an impact. It will affect the paycheck of everyone. It will have a huge economic repercussion. It is twice the money that is proposed to be taken out of the economy from the Defense Department sequester reductions beginning on January 2 that many are saying will have a huge impact on the economy.

I am not proposing the cut be extended but it is an issue and has to be dealt with in a serious fashion and the sooner the better.