Geithner's Secret Tax-Rate Freezing Powers

If Congress goes over the cliff, he can still stop a rate hike

Despite all the overtures from lawmakers who say they’re ready to compromise over the fiscal cliff, the Obama administration is exploring one way it could blunt a recession if Congress doesn’t sew up a deal by yearend. Failure would result in a jump in income tax rates at all levels, meaning more money taken out of people’s paychecks. Enter U.S. Treasury Secretary Timothy Geithner. The tax code gives him broad latitude to set withholding rates, and he could freeze the current levels to stave off effective pay cuts. Geithner said in an interview on Nov. 16 that Congress shouldn’t use his power as an excuse not to work out a deal, though. “It does not give me the authority,” Geithner said, “to let them avoid making some decisions on rates and policy.”

A freeze would cut by half the projected economic fallout in 2013 if the U.S. goes over the cliff. Mark Zandi, chief economist at Moody’s Analytics, says the move would keep $10 billion in taxpayers’ pockets about every two weeks and prevent a monthly hit of 1.5 percent to gross domestic product. It could help maintain current levels of consumer spending, though it wouldn’t prevent stock market declines, he adds. “We’re not going to get away scot-free if we freeze the withholding schedule,” he says. “It will help.”

Federal law says only that Geithner must set the withholding tables in a way that ensures collection of taxes over the course of a year. The statute is “susceptible to different readings,” says Michael Mundaca, the top tax policy official at Treasury until earlier this year. The agency might be more inclined to lock in the withholding levels if Congress says it will extend current tax rates but runs out of time to get legislation to the president before Jan. 1. “That’s going to be the very technical legal determination that Treasury and IRS are going to make,” says Mundaca, now a co-director of national tax at Ernst & Young. There’s also a precedent for changing the tables regardless of a revision in tax rates. President George H.W. Bush ordered lower withholding in 1992, saying it would pump $25 billion into the economy.

Another reason Geithner might act: Several Obamacare taxes will kick in come January, which will also drag down consumers’ take-home pay. Leaving withholding unchanged would provide a cushion in a fragile post-cliff economy.

It’s not a no-risk proposition for the administration, though. If Congress remains deadlocked and 2013 tax rates rise but withholding is frozen at 2012 levels, Treasury would eventually need to change the tables. Otherwise taxpayers would be subject to penalties and smaller or nonexistent refunds in early 2014. Either way, consumers could feel the pain.

Sabrina Siddiqui, a Treasury spokeswoman, declined to say when Geithner will release the withholding schedule for next year. Payroll departments hope it comes soon so they’ll have time to prepare, says Bill Dunn, senior manager of government relations at the American Payroll Association. That way, even if January paychecks are smaller, at least they’ll be right.

Before it's here, it's on the Bloomberg Terminal.