Turning the Cliff into a Launch Pad

One part of the dreaded fiscal cliff actually presents an opportunity that could be good politics and good economics. The temporary two-point cut in the payroll tax expires January 1 (along with the Bush tax cuts). The $1.2 billion sequester also kicks in.

Deficit hawks of both parties have been saying that it’s irresponsible to extend the payroll tax cut, while defenders of Social Security like the American Association of Retired Persons (AARP) are opposed to an extension for fear of diverting revenue from the Social Security trust fundsand adding ammo to the crusade for cutting back the system’s benefits.

But there is a nice opportunity here to turn a lemon into lemonade.

The economy is hardly robust enough to inflict a two-point tax increase on working people. For two-income households, that’s a four-point increase. That means, say, a $2,400 tax hike on a $60,000 family income. Nobody is going to remember that this was temporary; they will simply experience it as a tax increase on incomes that, on average, have been declining since 2008.

Secondly, liberals have long criticized the payroll-tax financing of Social Security as regressive. The tax is collected on the first dollar of income with no deductions or exemptions. And taxable income is capped at $110,100, so someone making $330,300 pays just one third the rate of people earning $110,000 or less. The original design for Social Security in 1934 assumed that once the system was mature (1980s), payroll taxes would be supplemented by general revenues.

To kill two birds with one stone, let’s continue the tax break for working people, but pay for it by increasing taxes on higher-income earners. That would make the system a less regressive tax and would prevent diversion of Social Security revenues.

It would also frame the issue of whose taxes should be cut, as well as the defense of Social Security rather more effectively than the presidential debate has done so far. And it would usefully put Republicans on the spot: Do they really want a tax hike on working people, at a time when Governor Romney pledges to cut everyone’s taxes? Don’t they want to shore up Social Security’s finances?

The annual cost of the payroll tax cut is about $95 billion a year, according to the Congressional Budget Office.

Suppose we increase taxes on people earning over $250,000 by more than that amount, to bolster the solvency of Social Security while we’re at it. This could be a combination of raising the cap on income subject to payroll tax, as well as a surtax on millionaires.

Several Congressional Democrats, notably Representative Chris van Hollen, top Democrat on the House Budget Committee, and Senate Majority Harry Reid, have expressed sympathy for some version of this idea

I leave it to President Obama’s political advisers to determine whether it is too close to the election to float this, lest it look like a gimmick. But it is a very good antidote to the post-election pressure to raise taxes and cut Social Security to head off the fiscal cliff. 

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