Do Black Friday Shoppers Have FICA On Their Minds?

Across America, diehard shoppers gathered in predawn darkness today to take advantage of Black Friday “door-buster” sales – or they stayed up past midnight last night, coffee mugs at their sides, to fill their online checkout carts.

Were they thinking about next year’s FICA tax rates as they decided how much holiday cheer they could afford to spread?

Our elected representatives ought to ponder this question as they begin yet another fiscal debate once their holiday recess is over. The question is whether to extend the allegedly temporary reduction in Social Security taxes on employee wages, which is due to expire on Dec. 31.

If Congress fails to act, Americans are going to see their Social Security withholding tax rate return to its original 6.2 per cent level at just about the time those holiday season credit card bills come due. Because FICA taxes will apply to the first $110,100 of wages earned in 2012, a worker at the ceiling will pay about $2,200 more in taxes next year if the rate increase goes into effect. A worker earning $50,000 will see a $1,000 increase next year.

Nobody likes higher taxes. Elected representatives don’t like to raise taxes, especially on large numbers of voters, and even more especially in election years. So the political bias clearly is toward keeping the tax rate at the lower level.

Last December’s tax legislation included the reduced rate to try to stimulate the economy and bring down unemployment, which was around 9.8 per cent at the time. The rate has come down only slightly, to 9 per cent, and the economy is poking along at a 2 per cent annual growth rate in the third quarter, which is not strong enough to put many more people back to work. So the economic bias also would seem to favour extending the tax break for at least another year.

But there are other dynamics at work. The inability of Democrats and Republicans to come to terms on a deficit-reduction plan is set to trigger $1 trillion in automatic spending cuts, spread over a decade, beginning next October. Half of the proposed cuts will come from the Pentagon budget and the other half from domestic programs. Advocates for both are howling that the budgetary axe is going to hit vital organs.

Moreover, the Social Security tax cut has already weakened the tenuous link between what people pay to support America’s favourite entitlement and what they hope to receive from it in their old age. Extending the cut, or expanding it as the president proposed in his stalled American Jobs Act proposal, takes Social Security a step closer to being universally acknowledged as the welfare program that it actually is. This would not be a bad thing, except that the program’s advocates have always felt that without the fig leaf of a “trust fund,” and the fiction that people pay in advance for their own benefits, Social Security benefits would be vulnerable to future budget cutting. Which, in fact, they are, since entitlement reform will be the key to eventually getting federal spending under control.

Against this backdrop, does it make sense for Washington to forego around $110 billion in Social Security tax revenue for a second consecutive year? To answer that question fairly, I think we have to ask ourselves: What did we get for this year’s cut?

There are three possible answers. The first is: not much, at least compared to what it cost. If reduced payroll taxes did not encourage at least an equivalent amount of consumer spending, then we did not get much stimulus bang for our buck. Advocates for the tax reduction have claimed that it accounted for perhaps 1 percentage point of GDP growth this year, which is about half of what we are ultimately going to get. They can point to the drop in unemployment over the past year to support their case. In a $13 trillion economy, a 1 per cent increase amounts to $130 billion of economic activity, not far from what the tax cut was projected to cost. Basically, it was a wash.

But the government did not have $110 billion lying around with which to finance the tax cut. The policy just added to this year’s deficit of more than $1 trillion. In effect, we had to borrow the money from China to get that boost to this year’s economic activity. Someday we will have to pay the money back. In the long term, there is no net benefit, unless the $110 billion we spent generated substantially more in additional activity. But it didn’t. And to the extent the increase in the federal deficit has discouraged businesses and investors from putting more capital to work in the economy, it probably cost us more in long term growth than it generated in the short term. Whatever benefit we received in 2011 is going to have to be paid back in future years, with “interest” in the form of additional drag on our national output down the road.

Some of that foregone tax revenue clearly did not boost the U.S. economy this year at all. Part of it had to go into consumer bank accounts or, more likely, toward the ongoing reduction in household debt on credit cards and mortgages. And part was spent on imported goods. We borrowed money from China, in part, so we could buy Chinese products. That helps put American store clerks to work, but it isn’t a very efficient way to stimulate long-term growth or even short-term hiring at good wages.

Republicans who are up in arms about the deficit are likely to demand offsetting spending cuts elsewhere in the federal budget in return for extending the Social Security tax break. That will further reduce the short-term stimulus effect in 2012, although it would at least avoid the need to repay the benefit later.

Back to those Black Friday shoppers: Are they counting on that break continuing next year, and boosting their spending accordingly? Or are they assuming that their payroll taxes are about to increase, and pulling in their horns as a result? Or are they ignoring, or ignorant of, the entire debate?

I’d assume the last option is the likeliest. I don’t think the tax break has bought enough short-term benefit to justify its 2011 cost, and I don’t think the outcome will be different in 2012. But we’re about to have a very loud political argument – once again – over something that won’t do much for our economy in the end.

 

For more articles on financial, business, and other topics, view the Palisades Hudson newsletter, Sentinel, or subscribe to my daily opinion column, Current Commentary.

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