As the January 1, 2013 fiscal cliff nears the Bush tax cuts are getting all the attention, but lost in all this coverage is the arguably more important payroll tax cut that is also set to expire on the same day. Currently, both sides are fighting over whether to extend all or some of the Bush tax rate cuts passed in 2001 and 2003. Democrats favor extending rate cuts for all incomes below $250,000, but Republicans refuse to agree to anything less than an extension of all the tax rate cuts. However, given the way the country’s tax code works, the payroll tax cut actually matters more for many working American. Despite this fact, there is currently no real push to keep the payroll tax cut alive from either the White House or congressional Democrats.
See also: A basic explanation of the fiscal cliff
The Bush tax rate cuts certainly do matter, but there are two big ways the effects of tax rate increases may be mitigated.
First, even if tax rates increase on January 1 Congress could simply pass a law later to retroactively reduce tax rates. Indeed, Democrats likely will begin to push for “tax cuts” for the middle class and poor on January 2, 2013 if the country does go over the fiscal cliff. Republicans will be under tremendous pressure to agree to those cuts, and the cuts will most likely be done retroactively so as to simplify the payment of taxes for everyone.
Secondly, as was so infamously noted by Mitt Romney in the 2012 campaign, nearly half of Americans pay no federal income taxes. So even if all the income tax rates go up nearly half the population will not feel the difference.
However, the payroll tax is absolute, and is paid by everyone earning wages or salary. Every American normally pays a 6.2 percent payroll tax to fund Social Security, but in 2010 the Congress and President Obama passed a two percent cut to the payroll tax. For someone making $50,000 gross income in a year, this tax cut amounts to an extra $1,000 in net income. If the payroll tax cut is not extended, Americans will immediately see their paychecks reduced. For poorer Americans, the increase in the payroll tax could force them to make difficult decisions about what to cut from the budget. Put simply, the impact of an expiration of the payroll tax cut is more immediate and more certain.
There are also ways the pain from an extension of the payroll tax cut could be mitigated. Congress and the White House could pass a new tax credit for the poor or middle class, or lower taxes in some other way to compensate for the loss income from the payroll tax cut. However, these kinds of measures would take time to negotiate, and thus far there is no sign that any in Washington is talking about it seriously. Meanwhile, at a time when many Americans are still struggling, and the economy is still in a recovery phase, most working Americans are facing a two percent pay cut on January 1 that no one is talking about.