Extending Payroll Tax Cut Is Hard Sell as 2011 Benefit Unproven

In selling an expanded payroll tax cut to lawmakers, the Obama administration faces the predicament it confronts in defending its $825 billion stimulus package: making a case that the economy would be worse without it.

“Politically, it’s difficult to make that argument,” said Chris Low, chief economist at FTN Financial in New York. “It was not easy to get that tax cut through, and it will be even harder to extend it.”

The most expensive part of President Barack Obama’s $447 billion jobs plan is expanding and extending a reduction in the payroll tax that funds Social Security. Economists say the results of this year’s payroll tax cut have been limited because much of the extra money workers took home went to cover rising gas prices, which reached a three-year high in May.

“Beyond allowing folks to spend more money on food and gasoline, spending is not apparent anywhere else in the economy,” said Mark Vitner, senior economist at Wells Fargo Securities in Charlotte, North Carolina.

Without the break, the U.S. economy likely would have fared worse. FTN’s Low estimates it added about .25 percent to the gross domestic product. Allowing the payroll cut to expire at the end of this year would cause a drag on economic growth in 2012, some economists said.

‘Saved Us’

“It probably saved us from recession,” said Mark Zandi, chief economist at Moody’s Analytics Inc. in West Chester, Pennsylvania. “The reason it didn’t juice up average spending is because it had to go to pay for higher prices.”

Because the U.S. personal savings rate remained steady at about 5 percent this year, it shows people were spending the additional money, Zandi said.

The aim of the payroll tax cut is to give workers more money, in an effort to spur consumer spending and stimulate the economy. The problem is it’s difficult to measure the effects because it’s impossible to know what would have happened without the cut, said Roberton Williams, a senior fellow at the Tax Policy Center, a nonpartisan research group in Washington.

“We don’t know how bad things would have been,” Williams said. “Taking it away would pull a lot of money out of consumers’ hands, and that would almost certainly have a negative impact.”

Personal spending grew at a 0.7 percent annual rate in the second quarter of 2011, the weakest since the end of 2009, according to the Commerce Department. The average gain in household purchases this year has been 0.1 percent.

Jobs Plan Centerpiece

The payroll tax cut would cost the Treasury $240 billion in forgone revenue and is the centerpiece of Obama’s jobs plan. If Congress doesn’t act, the tax in 2012 would revert to 12.4 percent, with workers contributing half, or 6.2 percent.

This year, workers are paying a lower 4.2 percent tax, a temporary reduction that was part of a comprehensive tax deal in December to extend the Bush-era tax cuts.

The Obama administration wants to further cut workers’ share to 3.1 percent in 2012. That would give a family earning $50,000 annually an extra $1,550 in after-tax pay. Obama also wants Congress to cut the employer’s portion of the tax to 3.1 percent on the first $5 million in payroll.

The Senate plans to take up Obama’s jobs proposal this month, said White House spokesman Jay Carney.

Less Than Hoped

Joel Slemrod, an economist at the University of Michigan in Ann Arbor who studies the public’s response to government stimulus, said recent tax cuts haven’t provided as big an economic boost as hoped for.

An analysis Slemrod co-authored last year found that only 13 percent of households said they “mostly” spent the extra money from the 2009 “Making Work Pay” tax credit that also aimed to stimulate economic growth. The payroll tax reduction was designed as an alternative to extending that credit.

In comparison, 33 percent of households in the analysis said they mostly saved the money and 54 percent said they used it to pay down debt.

Preliminary results show a similar percentage of households are spending money from year’s payroll tax cut, Slemrod said.

“These are pretty low and suggest that the multiplier effect through consumer spending would be low, though not zero,” he said.

‘Already Uncertain Economy’

Republicans in Congress are expressing reservations about the cut. In a Sept. 16 memo to colleagues, House Speaker John Boehner of Ohio and other Republican leaders raised concerns that expanding the tax break would lead to a bigger tax increase when the payroll tax reverts to the full rate in 12 months.

“There may be significant unforeseen downsides to large temporary tax cuts immediately followed by large tax increases,” the memo said. “In short, we are creating significant new uncertainty in an already uncertain economy.”

House Majority Leader Eric Cantor, a Virginia Republican, this week didn’t rule out House consideration of the reduction in payroll withholding taxes, saying that while such a move may not be “the most generative” for job-creation, “certainly it’s part of the discussion.”

The argument that economic growth would have been weaker without the tax cut echoes what defenders say about Obama’s 2009 stimulus package.

Curtailing Job Losses

While Republicans say an unemployment rate hovering at 9 percent for more than two years is evidence that the economic injection didn’t work, Democrats and the Obama administration say it curbed job losses.

An August report by the non-partisan Congressional Budget Office concluded that the 2009 stimulus increased the number of people working in the second quarter of 2011 by between 1 million and 2.9 million. The CBO said the stimulus reduced the jobless rate by between 0.7 percent and 1.8 percent in 2010.

Chris Varvares, senior managing director of Macroeconomic Advisers in St. Louis, said the payroll tax cut likely prevented a drop in consumer spending even though “there’s no compelling evidence either way.”

“If I had to make a bet on whether it helped support consumer spending, it probably did,” he said. “Many of the folks receiving it are financially stressed and could use the increase in the after-tax income.”

To contact the reporter on this story: Catherine Dodge in Washington at cdodge1@bloomberg.net

To contact the editor responsible for this story: Mark Silva at msilva34@bloomberg.net

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