Why Congress actually failed on payroll tax

It looks like Congress is about to assume its default position: In the face of an intractable partisan dispute over how to pay for a government initiative, don’t. If Democrats won’t cut spending, and Republicans refuse to raise anybody’s taxes, there is always the solution they both can agree upon—just borrow the money and increase the deficit.

The matter at hand is the payroll tax, of course. And after months of squabbling, it looks as if Congress is about to extend a “temporary” tax cut for another 10 months. And it will borrow $100 billion to do it. That would be OK if this was a short-term stimulus. But I don’t think it is.

How did we get here? To briefly review the bidding, in late 2010 Congress backed a plan by President Obama cut the employee share of the Social Security payroll tax from 6.2 percent to 4.2 percent for 2011 only.

Just as the tax cut was about to expire, Republicans and Democrats locked themselves in their usual fiscal death grip. But in a nice bit of political jujitsu, Democrats stole the GOP’s best anti-tax rhetoric. Letting the temporary tax cut expire as planned, they thundered, would raise taxes on 160 million working people.

The talking point was wildly successful. Just before they headed home for the winter holidays, Republicans went into duck and cover mode and Congress voted to extend the payroll tax break for two months—without paying for the extension, of course. The theoretically temporary tax cut is due to expire again in a couple of weeks. And until this week, Ds and Rs were rehashing the same old argument. Except for some tea party conservatives, most lawmakers insisted they wanted to extend the payroll tax break, but nobody would budge when it came to paying for it.

On Monday, the House Republican leadership announced it would support a 10-month extension without offsetting spending cuts. Problem solved. Just put another $100 billion on the tab.

This wouldn’t bother me if I thought the payroll tax cut was really going to expire in 10 months. But I don’t.  Given the Democrats’ politically successful claim that allowing the tax break to expire was akin to a tax increase, it is hard to imagine them abandoning the provision–or the issue– anytime soon.

And if Congress can’t agree on how to pay for it now, how will it do so at the end of the year? That’s exactly when lawmakers will be locked in an epic fiscal policy battle over what to do about trillions of dollars of other expiring tax cuts, how to dodge $1.2 trillion in automatic spending reductions that were mandated by Congress’ failed deficit reduction efforts last year, and how to increase the debt limit.

I can imagine the payroll tax extension becoming another version of the Alternative Minimum Tax patch–extended year after year with borrowed money.  To make matters worse, a permanently temporary tax cut further damages the credibility of the Social Security system which the payroll levy is supposed to fund. The government can fill the hole by shifting general fund dollars into the system, but this bit of legerdemain is not going to boost confidence in the retirement program.

Perhaps Congress will find a way to sort out this mess without adding trillions more to the budget deficit. Perhaps it will somehow let the temporary payroll tax cut quietly fade away at year’s end. But, somehow, I doubt it.