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Democrats want a bigger payroll tax cut than Republicans

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Democrats and Republicans have largely agreed that Congress should extend the payroll tax cut before it expires at the end of the month. They’re now battling over how to pay for the one-year tax cut. But there’s another major difference between the parties’ proposals that’s largely escaped attention. Senate Democrats don’t simply want to extend the 2 percent tax cut, as Republicans have proposed — they want to expand it even further, pushing for a 3 percent cut instead.

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Without congressional action, the Social Security tax on the first $106,800 in wages will go up from the current level of 4.2 percent to 6.2 percent. Senate Republicans have proposed keeping the tax at 4.2 percent, which would cost $120 billion, while Democrats would lower it further to 3.1 percent, at a cost of $256 billion — a change that’s twice as large as the GOP alternative.

As a result, the Democratic version could provide a bigger boost to the near-term economy, although the party’s proposal to pay for the tax cut by raising taxes on millionaires would have a bigger drag on economic growth down the road, says Gus Faucher, director of macroeconomics for Moody’s Analytics. He calculates that a stand-alone proposal to cut the payroll tax to the Democratic level of 3.1 percent — without paying for the change — would increase GDP by 0.5 percent more than keeping the tax at its current rate, as Republicans are proposing. “It could make a big difference. If there’s a European recession that takes off a half-point to growth, this could make up for it,” says Faucher, who estimates that the additional tax cut could create 350,000 to 400,000 more jobs over the next few years.

However, Faucher says that this economic forecast changes once you factor in the Democrats’ proposal to pay for the tax cut by imposing a surtax on millionaires. “By definition, you’re going to take money out of economy as you’re putting it in, so you’re going to reduce effectiveness of the stimulus,” he says. The changes would be staggered: The payroll tax cut would last through all of 2012, and the millionaire’s surtax would begin in 2013. “But in the longer run, there’s a long-term drag on growth,” meaning that the economy could bear the cost of this change for years if it isn’t phased out, Faucher concludes. Although this probably wouldn’t have an impact on GDP growth in 2012, it would lower the payroll tax cut’s boost to GDP and jobs from 2013 on, because of the simultaneous tax increase.

That said, the Senate GOP’s proposal could also reduce the effectiveness of passing a stand-alone tax cut. The GOP proposal would not only pay for their $120 billion tax cut, but also reduce the deficit by $110 billion by cutting spending by about $230 billion, according to the Congressional Budget Office’s new analysis of the bill. Significant spending cuts wouldn’t start taking place until 2014, but some of the proposed cuts could also have a dampening effect on the economy. The GOP proposal to freeze federal pay, for instance, would take money out of consumers’ pockets. And, on a dollar-for-dollar basis, the drag on the economy would be more direct than taking money away from millionaires, who tend to save more, as compared with middle-income federal employees, who would spend more freely, Faucher says.

On the whole, Faucher’s rough guess is that the complete Senate Democratic proposal — including both the tax cut and the means of paying for it — would be more stimulative than the complete GOP proposal, “primarily because it’s larger, with more money in the near-term economy.”

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