Extending The 2011 Payroll Tax Cut? How To Make The GOP Cry Uncle.

Senator John Kyl (R-AZ), who adamantly opposes tax hikes, has found one he really wants to help inflate. How?  By not extending the 2011 payroll tax holiday, he – and the GOP – would  raise the tax by about 50%. And note, most American households pay less in income taxes than they do in payroll taxes dedicated to Social Security, so the reduction from 6.2% to 4.2% of this tax was a healthy boost to this year’s pay. Also, it exclusively benefited the working poor and what’s left of the middle class since, due to a longstanding wage cap on FICA Social Security taxes, it applies only to those earning less than a very middle classy $106,800 in 2011. Employers, by the way, match employee FICA taxes, and notably, the payroll tax holiday does not extend to them; they pay an excise tax of 6.2% on wages paid (as well as 1.45% that is dedicated to Medicare, which also was not reduced for employees during the holiday). . .

Finally, although a controversial subject, the looming “social security crisis” being chicken-littled nearly everywhere is primarily based on inaccurate understanding of the trust fund and on ideological grounds. Relatively easy fixes exist, short of raising the retirement age or radically slashing benefits, to remedy any crisis that might ever emerge. The trust fund has a still growing $2.4 trillion surplus, and that money is dedicated by law to pay benefits. If there is a crisis, it’s in the Medicare Trust Funds and in high health cost inflation, but, for this article, let’s assume a Social Security “crisis” scenario is valid, paramount, and impending, as Kyl, most of the GOP, and some Democrats believe.

“Who lit that fuse?” asked the senator.

With that in mind, two simple declarative sentences during Senator Kyl’s FOX N*ws interview the other day made the news:

“The payroll tax holiday has not stimulated job creation. We do not think that is a great way to do it.”

With this, the senator may have unwittingly opened a door for Democrats and progressives to, in one package, lower taxes on most Americans and small businesses, ensure the viability of Social Security, and increase taxes on more highly paid wage earners. How?

All the above can be accomplished by remaking the FICA tax, moving it from a regressive (or flat tax) system to a progressive system, and doing so in a way that puts the GOP in a policy knot. To mix metaphors as if with a blender, the GOP can be hoist on its own ideological petard.

Nonetheless, a fight over extending the wage earner FICA holiday, and its further rate reduction to 3.2%, will become the battle du jour in Congress quite soon, perhaps today in the Senate. Democrats propose funding the 2012 FICA shortfall through a 3.25% surtax on incomes over $1 million. That, of course, with GOP control of the House, and near control of the Senate, will create a battle royal. This might be good for Democrats, though, if, for now, they move off the 3.25% surtax, as worthy as it is, and hide much of it in a FICA tax overhaul proposal that may isolate the GOP in dangerous territory. The appearance of “backing down” again to the GOP on millionaires’ taxes would be mostly sanitized inside a hugely popular Social Security program proposal. In the end, that can put the GOP on the policy defensive, and, if successful, collect increased tax revenue from the upper 10% via a reformed FICA tax system.

The positive effect on personal income of this year’s 2% break was large, especially since the payroll tax is presently regressive (at least at the time it is paid, if not in benefits received later).  Therefore, prior to 2011, when the social security tax was 6.2% it more negatively affected lower wage earners than higher wage earners due to the percentage of income that certain goods and services drain from family budgets at differing income levels. Poor families, for instance, spend a larger percentage of their income on transportation to and from work than do higher income families, even if the dollar value of their subway ticket is the same $40 per week. Known generally as Engel’s law, the same effect, in general, is true for many other items like food, shelter, health care, renters insurance, etc.

Regardless of the helpful economic effect of the 2011 holiday, though, the resulting 2011 FICA tax (4.2%) remained a flat tax, and, as we saw above, flat taxes like FICA are not an “equalizer” as nearly all Congressional Republicans, Herman Cain, Rick Perry, and some Democrats ardently believe. Their FICA arithmetic is linear, however, the distribution of flat taxes and their family budget consequences among families of different incomes is not linear. Engel curves are mostly nonlinear.

Here’s a counter-example of the flat tax that presents it in a different, friendlier light. Overall, the income gain from this year’s payroll tax holiday averaged approximately $1,200 per worker, but that is regressive in the best way, i.e. it boosts lower earner incomes for the basic needs of life (food, shelter, health care, etc.) on a percentage of income basis, and that helps the households in the lower 20% more than those at the $106,800 FICA taxable wage earner ceiling. As a result, lower income earners who receive a $500 FICA break can do more to meet basic needs (and perhaps have some discretionary funds) than a $1,200 FICA holiday for those better off who have already easily met their basic needs. That group, in fact, may actually buy things just for the joy of it, like televisions, row boats, tires, and funny costumes.

Yet, in the end, a flat tax does more proportionate damage than not. As we’ve seen, it especially hurts  lower income households’ living standards, and regrettably, that group of working poor has experienced virtually no net income growth for decades. Finally, though mildly debated by economists, the employer portion of the FICA tax system is differentially passed on to employees through wage reductions, benefit cuts, etc. So, as a consequence, where employees experience this they are potentially being assessed up to double their own FICA tax.

Senator Kyl’s inapt – but as you’ll see, helpful – framing of the issue as a “job creation” issue is, of course, the GOP mantra of this era. In effect, that religious belief translates, in practical terms, to six items: less taxes, lower taxes, no taxes, decapitate business regulation, and “Let’s hang Ben Bernanke.” Kyl’s “job creation” argument against extending the lower payroll tax through 2011 arises out of supply side economics, the granite hard foundation of GOP tax policy. Supply side policies typically stress tax reductions primarily to benefit “job creators,” those well-known 1 to 10%ers.  But that’s not all, Republicans, particularly the new crop of Tea Partiers everyone fears, rail around the clock against taxes on principle, taxes on anyone for anything at anytime.

So, inexplicably, here’s a tax cut – extending the payroll tax holiday – that is disliked by Senator Kyl, an exemplary supply sider. Michele Bachmann and others have this extension in their sights as well. Generally, the GOP loves this tax increase.What are they smoking? Certainly, one would think, unleashing the dollars on a recession-prone economy that would normally go to FICA would help spur production, and thereby create jobs, the very supply side goal sought by Republicans. Though they deny that jobs are created by a payroll tax reduction, this belief violates their foundational principle that all tax reductions “pay for themselves” by spurring economic growth. To Republicans, all tax reductions are, therefore, supply side in nature. So what’s the problem here? Why on earth oppose this one?

Here’s where it gets tricky. Understanding the nature of their supply side about face here is a clear path to attacking the GOP on its flank, and subject them to an unwanted limelight for awhile, perhaps until the morning of November 7, 2012. The Kyl-GOP position on ending the payroll tax holiday is akin to shooting themselves in the philosophical foot., i.e. effectively taking billions out of consumers’ wallets and giving them back to the federal government’s “entitlement” programs, which they also adamantly oppose. This is a real political bind for them. Certainly, the resulting income transfer to government will affect their 1%ers’ bottom lines, dividends, and incomes adversely when the majority’s discretionary income declines. Without a FICA break, they’ll be paying 2% more salary to Uncle. So, for the GOP to take such a pro tax hike stance over a 2012 FICA holiday is a mystery. And, does not Grover Norquist oppose any rescinding of a tax cut or tax expenditure once it’s enacted. And, for Gosh sake, as Romney said about another more personal issue related to the politics of lawn maintenance, “It’s an election year!” Why would the anti-tax, anti-government, anti-“entitlements.” pro Social Security privatization party want to be seen pushing a tax increase in an election year? Well, with a reform proposal, the Democrats can ask that on a daily basis. Betcha’ Boehner sheds tears.

And here’s yet another GOP hot spot: Social Security itself. It’s solvency. They’re frightfully concerned about that. They do their arithmetic and discover that Social Security will run out of money any day now. What shall we do? Their preferred choice, privatizing it via the equity markets, given the recent track record of the financial industry, is a non-starter. And that’s really all they have. So, now, how do we shore up the program, this mammoth “Ponzi scheme.” Well, they suggest raising the retirement age (not so good if you work in the trades where muscles are involved), they suggest cutting benefits (not so good if you’re already destined to live on dog food in emergency rooms), and they suggest everything short of deporting the elderly to Finland (Finnish is a hard language to learn). In Social Security reform, Americans view them like a Republican in a punch bowl. Democrats can keep that pleasant image in the forefront by actively battling them over a FICA tax overhaul that, through its progressive tax basis, and no income cut-off, they will  find it hard to respond to in a way that does not make them even more unpopular, particularly, I believe, among independents.

No, not that FICA!!

Senator Kyl, by tying the question to supply side economics through his use of the term “job creation,” may have invited an effective Democratic progressive flanking movement along these tactical lines:

Democrat/Progressives might say,

“Yes, Senator, we share your concern about the payroll tax holiday. But let’s also discuss the demand side, which is opposite the supply side on the macroeconomic coin. Low demand leads to less private sector revenue, less cash flow, less employment, and other things we all can agree need fixing. And, as you say, right now!”

Remember, the average American pays more payroll taxes than income taxes. And, as mentioned above, here’s the most important factor: payroll taxes are regressive, like 9-9-9. For just one more example, a poor family pays a higher percentage of its income on food than a middle class family, even though the middle class family spends more dollars on food. That’s regressive. Let’s ask Kyl and the GOP, “Can we both admit that such a regressive effect is a bad thing?” Publicly, where it matters, if framed in terms that appeal to the Democratic base and to independents, I’d dare Republicans to disagree without negative polling consequences.

Next, Democrats agree with the GOP (as they always seem to do on this) that Social Security “desperately needs fixing.”

Push the GOP regularly with their own beliefs that extending the payroll tax, a tax cut, would be a helpful macroeconomic remedy to move our stagnant economy forward and always mention you too believe the Republican mantra that “tax cuts create jobs.”

Caught like this, however, in a snit for the Democrats’ attempt to hoist them on their own supply side petard, the GOP will suddenly care about Social Security in its present form, something rarely show-boated. This is where Democrats and progressives can tie them  into knots.

“Well, yes, we too, as you well know, fear for Social Security’s future. And we support your proposed payroll tax hike, and we applaud your courage in going counter to your tax-free economics. But we, just as you have said over and over, we do not condone tax hikes on the middle class and poor alone, especially in a time of weak economic recovery while others in the top 10% of earners suffer little, if at all.”

Although in light of recent “tax the rich” gaming, the GOP always wins, in this case, they can be had. Spring the trap, and continue:

“So, we propose solving both the payroll tax regressivity problem and the Social Security viability problem in one big bipartisan package. We’ll start with your excellent idea of ending the payroll tax holiday as of January 1, 2012. We’ll both frame it as a ‘big solution for some big problems,’ giving you, the GOP, ample accolades for the original concept.”

Then, roll up their flank, and uncover the proposals:

1.  To assure Social Security viability for a century or more, we will erase the present payroll tax cutoff point. FICA will now be collected on all wage earners required to pay the tax regardless of income.

2.  In addition, we will transform the payroll tax from a regressive flat tax to a progressive tax with lowest rates for the lowest income wage earners, with proportionately higher rates for higher earners;

Excellent!

3.  With a progressive FICA system and the wage cut-off point removed, we will make employer FICA taxes on wages paid a progressive tax as well. Progressivity, in turn, greatly benefits small business owners with few employees.

All these things could follow, both arising from demand and supply side features of  the FICA overhaul:

• a marked decrease in FICA taxes on most of the American public, three quarters of whom pay more in FICA taxes than in income taxes,
• a similar decrease in FICA taxes owed by small businesses, freeing up money to invest, thus driving expansion and job growth, and
• a mechanism that will sustain Social Security for the long term.

And it is those constituencies who deliver GDP growth and, thereby, happily for all, increase incomes, private sector revenue, corporate profits, and, consequently, add to the wealth of the upper 10%, producing legal ecstasy for Republicans.  By golly, it’ll trickle up! Exxxcellent!

If someone runs with this, how can the GOP resist it without alienating more voters than they already have?

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