The President predicted that his tax plan would pass Congress, saying specifically that “nobody — Democrat or Republican — wants to see people’s paychecks smaller on Jan. 1 because Congress didn’t act.”
But if Congress does act, people’s paychecks will get smaller – a substantial amount, actually. And it will be a particular subset of people – the working poor, people who make under $20,000 a year, or families under $40,000.
The issue concerns the difference between the Making Work Pay tax credit, which was a flat rate of $400 per worker, and the payroll tax cut of 2%. Because of this, people who make less than $20,000 will get less than $400, and will see their tax bill rise.
“I think it’s an unintended consequence,” said a charitable Michael Linden of the Center for American Progress. “But that will have the effect of raising taxes on people making less than $20,000.” Linden says that there are advantages to the payroll tax cut. For one, it’s bigger – twice the size of Making Work Pay on an annual basis. “If what we should worry about is job creation, a bigger stimulus is better,” said Linden. “But on a micro level, I’m disappointed families will have to pay more.
The working poor will still benefit from the refundable tax credits like the expansion of the Earned Income Tax Credit. But those are in place now, and so it won’t make up for the fact that this bill puts in place a lower-class tax hike while saving millionaires $139,000 per person.
The maximum amount of money that taxes will increase for the working poor, given the federal minimum wage, is $270. But that’s about 4% of total income for those families. “I don’t want to lose 4% of income,” said Linden. And this isn’t a small subset: 25 million Americans would be affected by this tax change. “Conservatives spent the past year saying that nobody should face a tax increase. Under this deal 25 million people do,” Linden concluded.
This could be fixed with a relatively small amount of money. You could come up with a separate refundable tax credit making up the difference between the tax cut in the payroll tax for the working poor and the $400 from Making Work Pay. It would cost less than $7 billion dollars, to help out 25 million people. That’s less than 1% of the total cost of the bill. But it’s not in the Senate version of the bill which was released today.
This doesn’t even get into the concerns that the payroll tax cut could be extended, undermining the dedicated revenue for Social Security.
By the way, Larry Summers admitted that the payroll tax cut, as opposed to a larger Making Work Pay tax credit, was a Republican idea:
Q: So the only reason that the payroll tax holiday will provide more stimulus is because it’s twice as large. Making Work Pay was capped. Why didn’t you preserve Making Work Pay? Is it because, as the President said some months ago, it’s just a kind of invisible tax cut and didn’t provide any political benefit for the White House?
MR. SUMMERS: No, it came out of the process of compromise with the Republicans who were more attracted to the payroll tax holiday concept, and that was a proposal that, as had been coming out of here, we had been giving considerable thought to in the context of the President’s budget.
I wonder why they wanted a tax cut that gave more money to people at the higher end of the income scale? It’s not like that matches up with their entire ideology!
This is why Democrats who represent poor people are saying things like “Obamanomics looks like Reaganomics”.
…I should add that this also means the stimulative effect of the payroll tax cut is somewhat worse than Making Work Pay. As a general rule of thumb, the more money that goes to the lower end of the income scale, the more money that gets spent in the economy. Less money for the working poor and more for the more well-off reduces that multiplier.
UPDATE: Here’s a graphical representation of this:
UPDATE II: I forgot to cite Linden’s full paper on this.