A tax cut both parties should love -- but don't

By Chris Isidore, senior writer

NEW YORK (CNNMoney.com) -- Would you like a 6% raise in your next paycheck? Some economists want to give you one -- in the form of a payroll tax holiday -- to stimulate the struggling economy.

The payroll tax is the amount paid by both employers and employees to fund Social Security. Each pay 6.2% of a worker's salary, up to the first $106,800 of income.

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Because of that limit, the tax is one of the most regressive in place today, hitting the working poor and middle class much harder than the wealthy.

The nonpartisan Congressional Budget Office estimated earlier this year that eliminating payroll taxes was roughly two to four times more effective in spurring economic activity than a reduction in income taxes, the policy option that's getting most of the attention in Congress.

"This is a better tax cut than a general income tax cut," said Roberton Williams, senior fellow with the Tax Policy Center. He said getting more money to workers who earn less increases the chance that it will be spent rather than saved, a concept popular among Democrats.

And a payroll tax holiday would be much faster than sending out rebate checks.

"By cutting the payroll tax now, money gets in people's pockets by the next paycheck," he said.

Many economists say the employer portion of the payroll tax discourages hiring by making it expensive. So dropping the tax might free up cash that employers could use to add workers -- an idea that Republicans could likely sink their teeth into.

"The payroll tax is essentially a tax on employing labor," said John Makin, senior fellow with the American Enterprise Institute. "If you're an employer thinking of hiring, it'd be more attractive."

But the idea has garnered very little support from most Washington lawmakers in either party.

Democrats appear concerned with doing anything that would weaken the financial support behind Social Security. Republicans are more focused on extending the Bush-era tax cuts for top wage earners -- individuals who earn more than $200,000 a year and would see limited benefit from a payroll tax holiday.

"It is considered to be not very good politics in both parties," said Makin.

How do we pay for it?

A payroll tax holiday wouldn't be cheap. The Social Security Administration says the tax collected $689 billion in 2009.

But rising fears of a double-dip recession are bringing calls for another round of government stimulus. And some supporters think a payroll tax holiday would be worth it because of the tax revenue that would be lost if the economy stumbles.

"The big argument is it adds to deficit, but if you want to stimulate the economy, that's what you're going to have to do," said Makin.

The idea is being pushed by Republican Indiana Governor Mitch Daniels, a former budget director in the Bush administration. He is arguing for a one-year holiday on the employee portion of the tax.

"We have to get this economy growing at a naturally strong rate, and everything else takes second place to that," he told CNNMoney. "I haven't thought of an approach to boosting consumer spending and confidence that sounds any better."

In a recent column in the Wall Street Journal, Daniels proposed offsetting the cost of a payroll tax holiday with a number of spending cuts, including rescinding unspent money from the Troubled Asset Relief Program and pay freezes or cuts for federal employees.

Daniels thinks the lack of support for the idea in Congress is simply nervousness about looming mid-term elections.

"There seems to be no energy on either side for doing anything dramatic now," he said. "I hope that will change very soon."

Another way to pay for the holiday, proposed by New York University professor Nouriel Roubini, would be to raise income tax rates, allowing the Bush tax cuts to expire immediately for top wage earners, and in two years for most other taxpayers.

Roubini, who fears that the chance of a double dip recession has risen to 40%, has endorsed a two-year holiday on both halves of the payroll tax as a centerpiece of a new stimulus effort.

Alice Rivlin, senior fellow at the Brookings Institute and a member of the president's bipartisan deficit reduction commission, said she would only endorse a holiday if there was a mechanism to restore lost revenue to the Social Security trust fund.

But she said the importance of reducing the federal budget gap and finding a long-term solution to Social Security does not preclude a payroll tax holiday, especially if the risk of a double-dip recession continues to rise.

"[Deficit reduction] is a longer-run thing," she said. "It's not inconsistent with an immediate stimulus." To top of page

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