The GOP’s Payroll Tax Opportunity
Dec 10, 2012, Vol. 18, No. 13 • By JAMES C. CAPRETTA AND YUVAL LEVIN
Despite the outcome, Republican presidential nominee Mitt Romney did many things right during the course of this year’s campaign. Perhaps most notably, polls suggest that he was able to convince a plurality of Americans that the GOP’s plan for smaller government was better for promoting long-term economic growth than the president’s statist approach. But there was one line of attack Romney was never able to overcome, and which may well have cost him the working-class voters he needed to win: The Obama campaign effectively drove home the notion that Romney, and Republicans more generally, care more about the rich than the middle class.
There can be no doubt that answering that charge, by proving it wrong, will be essential to the GOP’s electoral future. That cannot mean adopting policies that Republicans don’t believe are right, but it must mean taking every opportunity to apply conservative principles for the benefit of working families, and showing voters why conservative ideas are better for everyone, emphatically including the middle class.
And yet, mere weeks after the election, we find congressional Republicans once again at risk of falling into the Democrats’ trap. The so-called fiscal cliff that is now riveting Washington’s attention involves the automatic application of the spending cuts agreed to in last year’s debt-ceiling talks combined with the expiration of several tax policies, which promises to increase the tax bills of many Americans. The two most significant tax increases result from the expiration of the Bush tax cuts (which would raise everyone’s income taxes) and the expiration of the payroll-tax holiday enacted in 2010 and renewed last year (which would raise everyone’s payroll taxes).
Republicans want to retain the Bush income tax rates for everyone, while Democrats want to retain them for Americans earning less than $200,000 (or $250,000 for couples). The dispute between them on that front, in other words, is about whether taxes will go up for upper-income households and many small businesses. It is a fight worth having, but both parties seem oddly complacent about the return of higher payroll-tax rates—which would hit far more Americans, and especially middle-class families.
For households squarely in the middle class, income taxes are less of a burden today than payroll taxes, because a variety of deductions, credits, and exclusions either exempt most of these households from any income tax liability at all, or leave them paying very little.
Not so with the Social Security and Medicare payroll taxes. Prior to 2011, the combined Social Security and Medicare payroll tax was 15.3 percent for households with incomes up to about $100,000, with half paid by the employer and half paid by the worker. For a family making $50,000 per year, that’s a tax liability of $7,650. According to the Tax Policy Center, households in the middle quintile of the income distribution pay an effective payroll-tax rate that is, on average, nearly three times what they pay in income taxes.
For these households, the 2 percent increase in the payroll tax that would result from a failure to renew today’s rates would be significant—a worker earning the median income would see his tax bill rise by $1,000 a year, which would be more than enough to make him take notice. The message for the GOP should be obvious: The party of low taxation must apply that broad principle not just to income taxes but to payroll taxes too.
And yet, rather than start a fight to prevent a middle-class tax increase, Republicans seem resigned to it, and may even leave an opening for the Democrats to oppose the increase while the GOP focuses exclusively on defending low rates for top earners.
This is not the first time Republicans have missed the opportunity to make the case for this middle-class tax cut. The idea of responding to our weak economy by lessening the tax burden on the middle class came first from conservatives. In 2009, as Democrats were preparing their pork-ridden stimulus bill, a few conservative economists—most notably Lawrence Lindsey (in these pages) and Douglas Holtz-Eakin—argued that Republicans should propose a significant reduction in the payroll tax as their alternative means of encouraging growth. Republicans never took the advice, and instead it was President Obama who seized that idea a year later.
In 2010, after the GOP’s midterm-election victory, the president proposed a one-year reduction in the Social Security payroll tax, taking the employee share of the tax from 6.2 percent to 4.2 percent (employers continue to pay 6.2 percent). Though reluctant, Republican leaders went along with the cut because it was combined with an extension of the Bush-era tax rates. In late 2011, the payroll-tax cut was extended for another year, through 2012.
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