Any payroll tax cut should be designed not to hurt lower-income workers


Andrew Fieldhouse
Economic Policy Institute
December 15, 2010

     
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Under the tax cut package negotiated by President Obama and Senate Republicans, a one-year 2% payroll tax cut would be substituted for the extension of the Making Work Pay (MWP) refundable tax credit proposed in the President’s budget request for fiscal year 2011. Many liberals have objected to the payroll tax credit on political grounds because it potentially undermines the dedicated funding source for Social Security, but there is also a compelling economic argument against this tradeoff. While the payroll tax cut comes at a much higher price tag and would thus have a greater net impact on job creation, the cut would actually lower disposable income for all tax filers earning less than $20,000 a year.

Dedicating the revenue associated with the payroll tax cut to an expanded MWP refundable credit would address both concerns. Alternatively, if political constraints require a tax cut rather than a refundable credit, we recommend adding a “hold harmless” provision to the payroll tax holiday to protect lower-income earners from seeing their disposable income reduced. The “hold harmless” provision would be relatively inexpensive, carry a particularly high “bang per buck” (by increasing disposable income of those individuals with the highest marginal propensity to consume), and help alleviate the rise in poverty associated with the recession.

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The MWP refundable tax credit — the largest tax provision of the American Recovery and Reinvestment Act — refunds 6.2% of earned income up to a maximum credit of $400 for individuals ($800 for joint filers). Making Work Pay also included a phase-out of 2% of income on earnings above $75,000 for income ($150,000 for joint filers), so individuals earning over $95,000 ($190,000 for joint filers) would not receive any credit.

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