Majorities exist in both the U.S. House and U.S. Senate for passage of the partial deal proposed by President Obama last week for avoiding the “fiscal cliff.” The president has called for extending the Bush tax cuts on income below $250,000 a year, renewing emergency unemployment benefits and allowing negotiations to continue on defense and domestic spending cuts.
If only the chambers could get to a vote. Put aside, for now, a comprehensive response.
Actually, a few other items belong in the stopgap arrangement, including clarity on the fate of the estate tax, set to revert to the Clinton-era rate of 55 percent on estates valued over $1 million. Also count among these items the future of the temporary payroll tax holiday. Unfortunately, this element has received too little attention, especially in view of the potential impact on the sluggish economy. Democrats and Republicans have jousted over the Bush tax cuts, seemingly in agreement that the payroll tax relief should expire.
That expiration would be misguided. The economy continues to be troubled by weak demand. The problem won’t be helped by taking money out of the pockets of those working for a living. The payroll tax holiday, first enacted at the end of 2010, is a 2 percentage point reduction in the levy, amounting to a $126 billion-a-year tax cut. It means typical Americans have more money to spend (generating economic activity) and to pay down debt (improving their financial position).
Concern about higher income tax rates for the wealthiest households misses a crucial point. Analyses show that such a slightly greater tax burden would have a negligible impact on the economy. At the same time, end the payroll tax reduction, and the fallout would be significant (unless offset in another way). JPMorgan Chase estimates that economic growth would be 0.6 percentage points slower if the payroll tax cut was not extended. Goldman Sachs has reached a similar conclusion.
One concern expressed about extending the payroll tax holiday involves undermining confidence in Social Security. The reduction diverts a dedicated funding stream for the retirement program. Worth stressing is that an extension should be limited to one additional year. More, this is a good time for government borrowing — with interest rates at such low levels.
As it is, three tools have been essential in bolstering the economy the past year, the policies of the Federal Reserve, extended unemployment benefits and the payroll tax holiday.
The challenge for Congress and the White House is managing well a set of postponed decisions, dealing with the long-term need to achieve fiscal order and the short-term need to spur the economy. That short-term need is the higher priority, and few steps would be more helpful than continuing the reduction in the payroll tax.