The Payroll Tax Hoo-hah

If you work for your living and have started to wonder if Congress will continue the 2% reduction in payroll taxes you’ve been receiving, I think you should relax on that point and worry about something else—like how badly the euro mess will drag down the US economic recovery.

Republications appear unwilling to vote for anything that anyone could possibly consider as a tax increase—and both they and the folks across the aisle agree not continuing the payroll tax reduction would be a “tax increase on the middle class.” Therefore, they need to find a way to continue the partial tax holiday.

Democrats (despite what they claim) understand that the state of the economy will be a major determinant in the 2012 elections. For the economy to grow, people (or governments) need to increase purchasing. Businesses expand when people buy more stuff and contract when they buy less stuff. No politician (as opposed to economists) will claim out loud that governments should be spending more in the near future (even if it is to buy stuff that will help us). Even Democrats are wearing hair shirts and lamenting the imbalance between Federal government income and expenditures. So increased government spending isn’t going to improve economic conditions. That leaves the consumer.

The payroll tax decrease is a highly inefficient method of increasing consumer spending because the beneficiaries don’t spend it all. Instead they look at their own financial situation and save some or all of the “largess” (or reduce outstanding debt, which is the same thing from their perspective). Nonetheless, if that money is yanked away from consumers, spending will decrease and since the government can’t make up the difference, total spending will decrease.

Decreased spending means lower demand for products, which means businesses will slow or stop their hiring and the double dip recession will be upon us. For Democrats that will be an election disaster. Even if voters “throw all the bums out” the Democrats are the bums who control the White House and Senate and could easily lose both. Even if the Republican bums in the House were replaced with Democrats, the net result would be a massive loss in Democratic power and increase in Republican power. No, the Democrats need to try to avoid that scenario.

Democrats have suggested “paying” for the continued payroll tax reduction by increasing the income tax on those earning over $1 million a year. Republicans, ignoring polling data that shows widespread public approval of higher taxes for the “rich,” have drawn a line in the sand. Democrats think a sirocco of public dissent will cause the Republicans to retreat on this issue. Some Democrats are chortling that they finally have the Republicans over a barrel.

Perhaps they are right; we’ll soon see, but my perspective is that the Democrats have the weaker bargaining position. Regardless of who is blamed for the “tax increase” should a stalemate mean the 2% payroll tax holiday comes to a screeching halt when the New Years’ ball in Times Square drops, the economy will quickly suffer and diminish Democratic chances for the 2012 elections—something, I think they’ll decide they can’t afford. Therefore, I expect the Democrats to cave first in order to reach a deal.

~ Jim