The Obama administration has a way to blunt about half of the fiscal cliff’s economic fallout for 2013, even if Congress stays deadlocked: Freeze paycheck withholding levels.
Treasury Secretary Timothy F. Geithner has the authority to set withholding, whether or not tax rates increase. He has said Congress should act to extend current rates for most taxpayers. A freeze could keep $10 billion per pay period in taxpayers’ pockets and prevent a loss of 1.5 percent of monthly gross domestic product, said Mark Zandi, chief economist at Moody’s Analytics Inc. in West Chester, Pennsylvania.
“You mitigate some of the downside, but not all of it,” Zandi said. “With each passing day, the economic damage would mount. We’re not going to get away scot-free if we freeze the withholding schedule. It will help.”
The decision would rest with Geithner as he and the administration of President Barack Obama weigh the effect of withholding changes on the economy and on negotiations with Congress. Freezing withholding in advance of a congressional agreement on tax rates may support consumer spending while removing some pressure on lawmakers to act quickly.
The move would make sense, especially if by late December a congressional deal to avert the tax-rate increases set for January looks probable though isn’t completed, Zandi said. Such a decision wouldn’t prevent stock market declines and other negative effects of failing to avert the automatic spending cuts and tax increases, he said.
Geithner commented on the subject on Bloomberg Television’s “Political Capital with Al Hunt” Nov. 16. He urged Congress to act on the fiscal cliff without saying exactly what he would or wouldn’t do.
“Don’t over-interpret what that authority gives me,” he said. “It does not give me the authority to give them, to let them avoid making some decisions on rates and policy.”
Sabrina Siddiqui, a Treasury spokeswoman, declined to answer questions about the scope of Treasury’s authority or its plans for releasing 2013 withholding tables.
The scheduled changes in tax rates are part of the $607 billion fiscal cliff of tax increases and spending cuts that would probably cause a recession in early 2013 if Congress doesn’t avert them. The economic effects of the higher tax rates would occur over the course of the year through increased paycheck withholding.
Lawmakers agree they don’t want rates to increase for most taxpayers. They are divided over Democrats’ proposed higher tax rates for top earners and the shape of longer-term deficit reduction.
If Congress does nothing, income tax rates at all levels would increase. Households in the middle 20 percent of the income distribution, or those earning between about $40,000 and $64,000 a year, would face an average tax increase of $1,984. That would decrease their after-tax income by 4.4 percent, according to the nonpartisan Tax Policy Center.
Most of that would occur through higher withholding that would reduce take-home pay.
Many taxpayers use the withholding system as a savings tool and a way to avoid penalties for under-withholding. They effectively loan the government money with no interest and get it back the following April when they file tax returns. In 2011 year, 75 percent of tax filers received refunds, which averaged $2,913, according to the Internal Revenue Service.
The tax code gives Geithner broad latitude to set withholding tables.
Purposes of Withholding
The statute says only that he must set the tables in a manner consistent with the purposes of withholding and the income tax rates. It doesn’t prescribe specific numbers or a specific relationship between withholding and the underlying rates.
The Treasury Department has a “huge amount of discretion,” said Bryan Camp, a tax law professor at Texas Tech University in Lubbock.
“It’s a game of ‘Simon Says’ where Treasury is Simon and ‘says’ through the tables,” Camp, who studies tax administration, said in an e-mail. “I do not find any significant statutory restrictions on what Simon can say.”
Michael Mundaca, the top tax policy official at Treasury until earlier this year, said the law is “susceptible to different readings.”
If it looks like a deal will be made to extend current rates, perhaps Treasury has the authority to freeze withholding, he said in an interview.
“That’s going to be the very technical legal determination that Treasury and IRS are going to make,” said Mundaca, now a co-leader of national tax at Ernst & Young LLP.
There’s also a precedent for changing withholding tables independent of a revision in rates. In 1992, in his State of the Union address, President George H.W. Bush announced that he was ordering lower tax withholding and said it would put $25 billion into the economy.
“With this change, millions of Americans from whom the government withholds more than necessary can now choose to have the government withhold less from their paychecks,” he said. “Something tells me a number of taxpayers may take us up on this one.”
For Geithner, freezing withholding without a deal carries risks. It could take pressure off Congress to act. If no agreement emerges, Treasury would eventually need to change the tables or leave taxpayers subject to penalties and smaller or nonexistent refunds in early 2014.
“The way our country is designed, this is a good thing,” Geithner said. “It does not give the secretary of the Treasury the ability to save the Congress from making decisions about tax policy and tax rates.”
A freeze of withholding rates also could offset a drag on the economy from the Dec. 31 expiration of a 2 percentage-point cut in the payroll tax and the beginning of several taxes from the 2010 health-care law.
The Congressional Budget Office estimates that allowing the fiscal cliff’s full tax increases and spending cuts to take effect would lower the GDP by 2.9 percent, with 1.4 percent of that coming from the income tax changes.
“From a consumer standpoint, it makes sense to blunt the impact of all these changes if there is some belief that they really will not” happen, said Bob Meighan, vice president of Intuit Inc. (INTU)’s TurboTax. “This is right after the holidays when people are trying to pay their bills.”
Bill Dunn, senior manager of government relations at the American Payroll Association, said payroll professionals want the administration and Congress to make a decision as soon as possible so January paychecks can be correct with little disruption.
“Whatever the decision’s going to be,” he said, “we need the decision to be made in a timely manner.”
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