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2011 Payroll Tax Holiday

Time to ‘Roll Out the Barrel’?

Mary-Jo Kranacher, MBA, CPA/CFF, CFE

After months of discussing the possibility of a payroll tax holiday, legislators caught the holiday spirit in December and passed the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010. As part of this legislation, the Social Security withholding rate was cut by two percentage points for employees—from 6.2% to 4.2%—on wages up to $106,800, the current annual cap. Consequently, workers received an increase in their net pay effective January 1, courtesy of Uncle Sam. Although an increase in disposable income is usually an occasion to celebrate, upon closer examination, we may have good reason to curb our enthusiasm.

The Costs

This one-year tax holiday will cost approximately $120 billion. If the cut reverts back to the previous FICA rates at the end of December 2011 as planned, it is likely to meet significant resistance. It will be perceived by many to amount to a nearly 50% payroll tax increase, and both political parties seem to lack the courage to make such difficult decisions needed to ensure our nation's long-term fiscal stability. Doing so would be especially problematic so close to an upcoming election year.

This one-year tax holiday will cost approximately $120 billion.

The payroll holiday replaces the Making Work Pay income tax credit, which was intended to help low-income households. But according to the Tax Policy Center, a nonpartisan group, the payroll tax cut will actually reduce benefits for the working poor and, instead, extend those benefits to workers with higher incomes.

To make matters worse, this tax cut is part of a larger package that comes with an $801 billion price tag. These cuts increase the deficit and continue to inflate the national debt, both of which will eventually generate pressure to reduce or eliminate safety-net programs such as Social Security, Medicare, and Medicaid, just as our population ages and needs these services most.

The Consequences

During the past few years, the long-term solvency of Social Security has been questioned. According to the IRS, “This reduced Social Security withholding will have no effect on the employee's future Social Security benefits” (www.irs.gov). The plan is for the U.S. Treasury to repay the lost revenue to Social Security from general revenues—something akin to borrowing from Peter to pay Paul. Continuing to ignore Social Security's challenges, and compounding them with irresponsible fiscal and tax policy, could lead to drastic measures for this and other entitlement programs in the not-too-distant future.

Some believe that this is merely a first step to promoting the privatization of Social Security. In fact, is it a coincidence that in a January 2010 report titled “A Roadmap for America's Future,” Representative Paul Ryan (R-WI) proposed that 2% of employees' payroll taxes be diverted for investment into personal retirement accounts?

We're told this legislative package is intended to be a stimulus measure. With the widespread pain of the ongoing financial crisis, few would argue against trying to fix what's ailing our economy. But lowering tax rates indiscriminately is not going to solve one of the biggest problems plaguing our economy—unemployment. It's hard to fathom, for example, how establishing a 35% tax rate on estates over $5 million is likely to act as an economic stimulus and create more jobs. By the same token, for a payroll tax reduction to be effective in boosting the economy, our legislators might have extended this “holiday” to employers as well as employees.

If the health of our economy is based—at least in part—on people's expectations for the future, how can we be optimistic when we're drowning ourselves and future generations in a pool of debt? In fact, concerns over the legislation's long-term fiscal effects caused sell-offs in U.S. Treasury securities after the agreement was announced in early December. Moody's also warned that the costs associated with this legislation could negatively impact the federal government's AAA credit rating.

So, before we prepare to “roll out the barrel,” let's take a sobering look at the real effects of this sweeping tax reform.

As always, I welcome your comments.

Mary-Jo Kranacher, MBA, CPA/CFF, CFE. Editor-in-Chief. ACFE Endowed Professor of Fraud Examination, York College, The City University of New York (CUNY) mkranacher@nysscpa.org.

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