The pandering, boneheaded motives behind the payroll tax holiday

Now that the election has delivered a status-quo result, we head into the holiday season with the game of fiscal-cliff chicken well underway. Republicans claim that they have a mandate to keep tax rates as they are now because their party maintained control of the House; Democrats maintained control of the Senate and the White House, and thus claim a mandate for raising taxes. Both sides claim that they want to protect the middle class, and both sides have taken the middle-class tax rates hostage in demanding total victory.

The game of chicken threatens to play out all the way to the end of the holiday season, and perhaps even longer. Democrat Patty Murray, the new chair of the Senate Budget Committee, has said that raising tax rates is a higher priority for her panel than actually producing a budget, making the latter conditional on "get[ting] Republicans to quit protecting the wealthy." Murray now leads a contingent of Democrats pushing to force the U.S. over the fiscal cliff at the end of the year in order to use the political fallout to get tax hikes from Republicans.

And remember: Christmas isn't the only holiday season coming to an end next month, and the rich aren't the only people who will see their tax bite increase. Most have forgotten that the payroll-tax holiday expires this year, and that beginning in January, the federal withholding from employee salaries will increase significantly — almost entirely hitting the working and middle classes.

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For too long, we took a holiday from fiscal reality.

Two years ago, the same president and congressional leadership had the same fight over budgets, stimulus approaches, and tax rates. Both sides wanted to appear to be champions of the middle class. Republicans argued then (as now) that tax hikes on anyone would crater the economy, while Democrats argued then (as now) that fiscal responsibility required the rich to pay their "fair share." Nothing got resolved in that standoff except to agree to keep the status quo a few months longer, and to pander to the middle class with an essentially meaningless tax cut that turned into a trap.

Why meaningless? Both sides sold the payroll tax holiday as an economy-stimulating policy. As such, though, it simply followed the failures of Barack Obama's Making Work Pay weekly tax rebate and George Bush's lump-sum tax rebate. The numbers involved, about $20 per week, hardly constitute an incentive for spending freely. In the first year of this particular holiday season, personal consumption expenditures (PCE) increased by 3.1 percent (annualized) in the first quarter, but then only rose 1.0 percent, 1.7 percent, and 2.0 percent in subsequent 2011 quarters. In the year prior to this policy's enactment, PCE grew at more than 2.5 percent each quarter, hitting 4.1 percent in the final quarter before Congress passed this particular stimulus. It's possible to argue that these 2011 numbers might have been worse without the tax holiday, but it's impossible to argue that it led to resurgent economic growth.

Furthermore, this "holiday" comes with a price. The money comes out of the Social Security Fund's revenue stream, which already doesn't produce enough income to cover outgoing expenditures. This stimulus measure is aptly named, as it provides a "holiday" from fiscal sense in a program that is already on the road to insolvency, if not as quickly as Medicare. At least in principle, this tax cut doesn't keep funds from the government — it takes it from the retirement funds of the taxpayers themselves, just as if the money had come out of a 401(k) account.

Ending the payroll tax holiday will be much more complicated than creating it, however. Even though the decrease in withholding amounts to robbing Peter to pay Peter, ending it will look very much like a tax hike to those same middle- and working-class families that expect Congress to stick it to the wealthy instead. The political impact of that increase in withholding may never materialize, as the economic impact of creating it certainly didn't, but the risk of blowback has both parties taking a bipartisan vow of silence on this issue. Unfortunately, that silence leads to another round of pitting expectations against reality. Regardless of what happens in the next five weeks, in reality, taxes will go up for everyone — not just the wealthy.

Perhaps Congress will take a lesson from this experience. When faced with systemic economic problems, short-term gimmicks end up costing much more than they produce, both economically and politically. If the same congressional leadership that exists today had taken a reform-minded approach to the tax system in 2010 to resolve the standoff on tax rates, we could have not only avoided at least two more standoffs on the problem, but also created the kind of investor confidence that would have brought real and long-lasting economic growth. Congress and the White House could have wrung much more of the short-term gimmicks from both the personal and corporate tax systems, restoring the ability of capital holders to price risk more clearly, and to create jobs that would improve revenues organically rather than confiscating more of the capital needed to expand the economy.

Instead, we took a holiday from fiscal reality. Congress now has the opportunity to use the bipartisan desires for tax reform to resolve this standoff. Let's hope they use that opportunity more wisely than they have over the last two years.