Fiscal Restraint Takes a Back Seat in Tax Cut Deal
Policy + Politics

Fiscal Restraint Takes a Back Seat in Tax Cut Deal

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The deal finally approved by Congress and signed by President Obama on Friday to extend a payroll tax holiday and keep unemployment insurance checks flowing to millions of Americans was a case of political necessity trumping fiscal restraint.

After suffering a humiliating defeat at the hands of Obama and congressional Democrats for attempting to block the Senate-crafted plan, House Republicans agreed to go along and extend a two percentage point payroll tax cut and emergency unemployment benefits for an additional two months.

But to get there, Democrats and Republicans alike quietly engaged in some creative and controversial revenue raising, while skirting legal budget constraints designed to discourage deficit spending.

Democratic and Republican leaders spent months trying to work out a long-term compromise on a tax and unemployment benfits package, but couldn’t agree on the precise size and shape of the plan or how to pay for it. While House Speaker John Boehner and House Republicans blocked final action on a deal for much of the week, in the end neither party was willing to accept blame for a tax increase on millions of Americans at the start of a crucial election year.

The final agreement approved in both chambers by unanimous consent on Friday puts off the most difficult decision making until early next year, when House and Senate negotiators will once again, go back to the drawing board.

“We have a lot more work to do,” Obama said Friday before departing Washington to join his family in Hawaii to celebrate Christmas. “This continues to be a make or break moment for the middle class in this country, and we are going to have to roll up our sleeves together – Democrats and Republicans – to make sure that the economy is growing and to make sure that more jobs are created.”

The two-month compromise, which also includes important Medicare provisions, will cost the government $33 billion over the coming decade. Here’s how that breaks down:

  • $20.1 billion over 10 years for the two-month extension of the payroll tax break that was enacted last year. About 160 million workers’ share of the Social Security payroll tax will remain at the current tax level of 4.2 percent, instead of reverting to 6.2 percent next month as required under the enabling legislation. This means a continued salary boost of about $20 a week for an average worker earning $50,000 a year.

  • $8.5 billion over 10 years to extend for two more months the availability of unemployment benefits in all tiers of federal emergency unemployment compensation. This will prevent two-to-three million unemployed people from losing jobless benefits early next year that average $300 a week.

  • $4.1 billion over 10 years to prevent a scheduled sharp reduction in the rates that doctors are paid to treat Medicare patients, as well as to address other Medicare-related issues. Under the current law, the Medicare payment formula is set to slash payments to physicians by 27.4 percent on Jan. 1. Without this congressional intervention, many doctors would be unlikely to take on Medicare patients with such diminished fees. .

The two-month extension of the tax holiday, unemployment insurance, and the so-called “Doc Fix” will be financed by levying a one-tenth-of-a-percentage point increase on guarantee fees on new homes backed by mortgage giants Fannie Mae and Freddie Mac – at a likely cost of about $17 a month for a person with a $200,000 mortgage.

The idea of boosting the fees Fannie Mae and Freddie Mac collect was first floated by the now defunct congressional Super Committee tasked with finding $1.2 trillion in deficit-reduction measures, and it garnered bipartisan support at the time. But housing experts say the additional fees could prove to be another headwind for the shaky housing market.

Even though Fannie Mae and Freddie Mac don’t issue mortgages directly, they buy them from lenders and repackage them into securities that are then sold to a wide range of investors. The two agencies now own or guarantee about half of U.S. mortgages, or nearly 31 million loans. To protect against any defaults, they charge the originating lenders “guarantee” fees.

“Fannie Mae and Freddie Mac are currently being propped up by taxpayer dollars, so it makes no sense to use them as an ATM to pay for other government spending,” Rep. Dennis Cardoza, D-Calif., recently told The Fiscal Times.

But Fannie and Freddie are such unpopular agencies in the wake of the housing crisis – and their activities are so arcane and obscure – that they proved to be the perfect piggy bank for Congress to cover the cost of the extended benefits. Even then, congressional leaders were forced to exempt the bill from the pay-as-you go provisions of the federal budget law. That law would have required the new fees to offset the spending costs within five years or trigger across the board spending cuts or “sequestration.”

It will take a full decade before those fees will generate enough revenue to cover the costs. Until then, the congressional action will add to the deficit. The plan for extending the payroll tax cut for two additional months contains a pro rata limitation on the amount of earnings eligible for the tax cut of no more than $18,350.

A major stumbling block to the final agreement was House GOP complaints that extending a payroll-tax holiday for only two months would create serious administrative problems for businesses and showcase Washington’s growing penchant for “kicking the can down the road.” Businessmen and payroll executives complained that the two-month extention would pose problems for them to manage and increase tax-compliance costs for small businesses.

As originally passed by the Senate a week ago, the $18,350 cap would be administered by the employer or payroll service provider during the first two months of 2012. As part of the final compromise worked out to placate House Republicans, the $18,350 cap will be administered by the employee, who would pay back any tax reduction on income in excess of the cap at the end of the year on his or her annual tax return. This payback provision only applies to employees who earn more than $18,350 during the first two months of 2012 and is moot if the payroll tax relief is extended for the entire year.

“We are pleased that small businesses will be spared complicated changes to the payroll process with this agreement,” said a spokesman for the National Federation of Independent Business, a politically influential small business group. “But doing tax policy two months at a time is not ideal. We hope both chambers [of Congress] are able to hammer out a deal well before the end of February to avoid a repeat of the situation we saw this week.