Tax Analysts Blog

Payroll Tax Politics

Posted on Dec 12, 2011

The GOP never met a tax cut they didn't like ... until now. That's how Democrats portray Republican reluctance to extend the payroll tax breaks scheduled to expire at the end of the year. Casual observers of U.S. tax policy can be forgiven for doing a double-take here. Election-year politics has turned conventional wisdom on its head.

Here's some relevant background.

Anyone who earns a paycheck is all too familiar with the various subtractions that comprise the difference between your gross and net pay. Beyond what they take out for federal income taxes, there are further withholdings under the Federal Insurance Contribution Act (FICA). These FICA taxes are entirely separate from federal income taxes, though both are based on an individual's salary and wages.
Thus we distinguish between "income" and "payroll" taxes.

Your payroll taxes consist of mandatory contributions to our Social Security and Medicare systems. The standard Social Security tax is 6.2% of your wage. There's a separate 6.2% Social Security tax that your employer pays, which isn't reflected on your pay stub. The Medicare tax is 1.45% of your wage, again with a matching tax paid by your employer. Total payroll taxes are 15.3%, with the burden evenly split between you and your employer.

Who pays these payroll taxes? Everyone who earns a paycheck. Rich and poor alike -- even those workers who earn so little money they don't owe federal income tax. That said, the design of the social security tax is regressive. The amount of taxable wages is capped, so you don't necessarily pay more as your salary increases. High earners pay this tax, but the charge effectively "turns off" for wages over the cap ($106,800 for the 2011 tax year).

Last year President Obama "caved" to Republican demands and extended the Bush-era income tax cuts for another two years. One of concessions he won in that compromise was a temporary reduction in the employee share of social security taxes. This lowered the rate from 6.2% to 4.2%, but only temporarily. The tax rate reverts back to 6.2% on January 1, 2012, unless Congress acts to extend the measure.

Here's where the politics become upside down. Obama not only wants to preserve the tax break (huh ?), but he wants to make it bigger (huh ??) slicing the tax to 3.1%. GOP lawmakers are lukewarm on these tax cuts (huh ???), with some lawmakers willing to let the rate revert back to 6.2%. The source of GOP opposition ranges from the proposed pay-for, a millionaire surtax, to whether the tax cuts will deliver the advertised stimulative benefits. No doubt it bothered many in Congress that the proposed extension is temporary while the surtax is permanent.

Still, this is atypical behavior on the part of my Republican friends. I can't remember the last time they dithered over a tax cut, especially on the basis of questioning the underlying economics. Really? When has that ever mattered? This is the same group that sold us section 965 repatriation as a jobs creator.

Frankly, most people in Washington will tell you the root of GOP opposition is that Obama supports the tax cut. The last thing the GOP wants is to hand him a perceived legislative victory with the elections less than a year away -- despite the fact these same payroll tax cuts were originally a Republican idea before the President leached on to them in 2010. None of that matters; partisan politics trumps common sense.

It seems the GOP playbook reads as follows: "Vigorously support all tax cuts, except the ones Obama proposes." The problem is that American voters can see right through that stance. The more astute Republicans now realize they have little choice but to support the President and vote to extend the payroll tax cuts. Otherwise they, themselves, become tax raisers. How ironic would that be?

Personally, I expect the tax cuts will be extended. But stay tuned, the real battle will be whether the move adds to the country's deficit or is paid for with other revenue raisers.

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