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Payroll Tax Cut Debate Shifts to Squabble Over How to Cover Cost

Top lawmakers from both parties are pursuing different ways of offsetting the cost of extending a U.S. payroll tax cut, establishing markers for negotiations over how to prevent the break from expiring Dec. 31.

Senate Minority Leader Mitch McConnell of Kentucky hasn’t said how Republicans plan to cover the forgone revenue from extending the 2 percentage-point reduction in employees’ portion of the Social Security tax.

Republicans are considering using an extension of the pay freeze for federal workers to offset part of the payroll tax cut, said a Republican senator familiar with the talks who didn’t want to discuss the proposal publicly before its release.

McConnell made clear in a Senate floor speech today that Republicans “will put aside their misgivings” about extending the payroll tax holiday because “it will give some relief to struggling workers who continue to need it.”

Democrats have proposed extending and expanding the tax break. The Democrats’ $265 billion proposal would be offset by a permanent 3.25 percent surtax on annual income exceeding $1 million; a test vote is planned for this week on it.

“You can take to the bank” the fact that the payroll cut will be offset if the parties can agree on an extension, House Speaker John Boehner said today. Such an accord may prove difficult as McConnell yesterday dismissed the attempt to pair temporary tax cuts with permanent tax increases as a political ploy rather than a sincere attempt to pass legislation.

Political Divide

The discussions on how to offset the payroll tax cut extension will demonstrate the size of the divide between the parties on fiscal policy that helped lead to the impasse of Congress’s deficit-reduction supercommittee this month.

“We’re going to enter into a phase now of back-and-forth gamesmanship over how to pay for the payroll tax,” said Brian Gardner, the senior vice president for Washington research at KBW Inc. “Even those members who question its value come to the conclusion that voting against it is a political loser. It’s really a question of how you pay for it.”

Supercommittee members couldn’t agree on raising taxes for high earners, and that issue still separates lawmakers.

“We think it ought to be paid for and not by raising taxes on the people we’re depending upon to create jobs,” Senator John Cornyn, a Texas Republican, said yesterday.

Affected by Surtax

Alan Krueger, chairman of President Barack Obama’s Council of Economic Advisers, disputed that point, and said “very few” employers would be affected by the Democrats’ income surtax. Obama travels to Pennsylvania today to make the case for the payroll tax cut.

“The president’s proposal puts the burden on those who can most afford it,” Valerie Jarrett, a senior adviser to Obama, said today on MSNBC’s “Morning Joe” program. She suggested that the White House is open to other ways to pay for the $265 billion tax cut but wouldn’t be specific.

“The president is interested in making sure that whatever we do is fiscally responsible,” she said.

Republicans distributed an analysis from the nonpartisan Joint Committee on Taxation showing that 34 percent of business income that flows through to individual returns would be subject to the surtax. The analysis doesn’t estimate the size of those businesses or how business owners would respond to the tax increase in their personal spending or business decisions.

‘Critical Time’

“This is a critical time for the economy,” Krueger said at a White House briefing yesterday. “Extending the payroll tax cut will strengthen the recovery.”

Letting the tax cut lapse would mean a $1,000 tax increase for a family earning $50,000 a year. Crimping consumer spending at a time when the economy faces “weak aggregate demand” would be a drag on growth, Krueger said.

The Democrats’ plan would expand the 2-percentage-point reduction to 3.1 percentage points for 2012. It would cut by 3.1 percentage points the tax on employers’ first $5 million in wages and remove employers’ tax on certain wage growth. The proposal would move money from the general fund to the Social Security trust fund, which is supported by the payroll tax.

Two House Republican leadership aides said there was little resistance among rank-and-file members to extending the employee payroll-tax holiday as long as it’s offset with spending cuts. An employer-side expansion of the tax cut may be more problematic because Republicans would want to offset that break with spending cuts as well, one aide said.

No decision has been made on whether an extension of expanded unemployment benefits must be offset, said the aide.

McConnell Proposal

McConnell’s proposal to offset the cost of extending the payroll tax cut runs counter to arguments by some Republicans that tax-cut extensions shouldn’t be paired with other measures to prevent them from increasing the federal budget deficit.

“With this $15 trillion debt we now have, bigger than our economy, we need to be paying for a measure like this that’s temporary, and I think in the end we will pay for it,” McConnell said.

McConnell’s plan likely won’t have unanimous support from his members, who are split on whether to extend the tax cut and whether to offset it. That’s a change for a party that is usually united on tax cuts.

Massachusetts Republican Senator Scott Brown said yesterday that Congress should follow its precedent in deciding not to offset the cost of the tax cut when it was enacted last year. Republican Senator Mike Enzi of Wyoming said he doesn’t think the payroll tax cut has created jobs.

‘Sensible Ways’

Krueger wouldn’t say whether Obama would accept an extension of the tax cut that isn’t matched with higher revenue or budget cuts elsewhere. The administration is “open to economically sensible ways” to offset the plan’s cost, he said.

Senate Majority Leader Harry Reid didn’t signal what Democrats will do if their proposal containing the high-earner surtax fails. Democrats control 53 of the Senate’s 100 seats. Republicans can use procedural moves to require a 60-vote threshold.

“We are going to continue working until we get the payroll tax extended,” Reid, a Nevada Democrat, said yesterday.

House Republicans, who control that chamber, are weighing their options, said Dave Camp, chairman of the House Ways and Means Committee.

“We’re talking about it and trying to find a path forward through the end of the year,” he said after a meeting of House Republicans today.

Camp, a Michigan Republican, said lawmakers haven’t decided yet whether they will try this year to extend expiring miscellaneous tax breaks, such as the research and development tax credit.

To contact the reporters on this story: Richard Rubin in Washington at rrubin12@bloomberg.net; Steven Sloan in Washington at ssloan7@bloomberg.net

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

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