Tax Day 2013: For the vast major, it’s all about the expired payroll tax cut
Around the enactment of the lame-duck budget deal, which permanently extended the Bush-era tax cuts and most expiring income tax provisions for roughly 99 percent of households, policymakers were claiming to be preventing the largest tax hike in American history. Yet every worker saw their taxes go up between 2012 and 2013.
And during the “fiscal cliff” policy debates, some conservatives (wrongly) warned that full expiration of the Bush tax cuts would push the economy back into recession. Neither event occurred, but enough other fiscal retrenchment is slated for 2013 that the labor market will likely experience renewed deterioration—in large part because the expiring two-percentage-point Social Security payroll tax cut went ignored during the policy debate.
So with tax day upon us, here’s a brief overview of the budgetary and economic impacts of tax changes for 2013. Notably, the relatively well targeted payroll tax cut’s expiration is the tax change overwhelmingly felt by the vast majority of households, whereas other tax changes were rather progressively targeted. Correspondingly, the expiration of the payroll tax cut will exert a fairly sizable drag on economic growth in 2013, whereas tax changes more targeted to upper-income households pose only about one-fifth as much of a drag per dollar.
The American Taxpayer Relief Act (ATRA) ended the Bush-era income tax rate cuts for households with annual taxable income over $400,000 ($450,000 for joint filers), raised the top statutory capital gains and dividends rates to 20 percent for households above this threshold, and reinstated the personal exemption phase-out and the limitation on itemized deductions for households with annual adjusted gross income above $250,000 ($300,000 for joint filers). Below these cutoffs, ATRA permanently extended the Bush-era tax cuts. Additionally, the Alternative Minimum Tax parameters were permanently indexed to inflation and the top estate tax rate was slightly increased from 35 percent to 40 percent. Ignoring estate tax changes, the ATRA ended 73 percent of the “upper-income” Bush tax cuts, as defined by the Obama administration. Overall, the deal raised $617 billion over fiscal 2013-2022 relative to current policy, locking in 83 percent of the $3.7 trillion revenue loss from full continuation of the Bush-era tax cuts and recent estate tax cuts.
So almost every household kept their full benefit from the Bush tax cuts, but many households never received much benefit in the first place, because the Bush tax cuts were heavily skewed toward the very top of the income distribution. The top 1.0 percent of household by income received 38 percent of their total benefit in 2010, more than the lower earning 80 percent of households’ combined share.
Several tax changes targeted toward upper-income households enacted as part of the Affordable Care Act also took effect in 2013. Most notable are a 0.9 percent surcharge on earned income and a 3.8 percent surcharge on investment income for households with taxable income and adjusted gross income, respectively, above $200,000 ($250,000 for joint filers). Additionally, the bill raised the floor deductibility of medical expenses from 7.5 percent to 10 percent of AGI (affecting only the roughly one-third of households itemizing deductions) and limited health flexible spending arrangements in cafeteria plans.
Relative to a baseline of zero tax increases—meaning full continuation of the Bush-era tax cuts, AMT patch, payroll tax cut, and routinely renewed business tax provisions, as well as preventing new taxes from the ACA taking effect—the average household saw a $1,273 (9.5 percent) tax increase in 2013, according to distributional analysis by the Tax Policy Center. Households earning less than $200,000 annually (95.7 percent of households) paid over 50 percent of the share of the net tax increase despite being totally unaffected by the partial expiration of the upper-income Bush tax cuts and largely unaffected by the new ACA taxes.
That’s because roughly 57 percent of the total tax increase was from expiration of the payroll tax cut, which took an average of $721 out of households’ pockets, and decreased overall disposable income by roughly $114 billion. But for households earning under $200,000 annually, the expiration of the payroll tax cut accounted for over 98 percent of reduced disposable income from tax changes taking effect in 2013. As the figure below depicts, tax changes outside the payroll tax cut’s expiration were distributed quite progressively.
Unlike the Bush-era tax cuts, the payroll tax cut was designed as effective fiscal support, meant to boost consumption by households likely to quickly spend, not save, an extra dollar of disposable income. The Social Security payroll tax is a more regressive tax structure than the tiered marginal rates of the progressive individual income tax—hence cutting the payroll tax boosted more disposable income for more low- to moderate-income households than say proportional reduction in income tax rates (e.g., their share of the Bush tax cuts).
During the preceding debate over the “fiscal cliff”—government spending cuts and tax increases collectively threatening to push the economy back into recession—my colleague Josh Bivens and I estimated that the expiration of the payroll tax cut would reduce disposable income by $115 billion, slow real GDP growth by 0.9 percentage points and lower nonfarm payroll employment by nearly 1.1 million jobs. Conversely, at the time we estimated that expiration of the upper-income Bush-era tax cuts—as defined by the Obama administration—would reduce disposable income by $52 billion, but only slow real GDP growth by 0.1 percentage points and reduce employment by roughly 100,000 jobs. We estimated that the upper-income Bush tax cuts were about one-fifth as effective per dollar at supporting jobs as the payroll tax cut.
We subsequently estimated that the partial expiration of the upper-income Bush-era tax cuts will shave less than 0.1 percentage points from real GDP growth and reduce employment by roughly 80,000 jobs, relative to 2012 fiscal policy. Scaling back these tax increases will cost $344 billion over fiscal 2013-2022, relative to the administration’s previous proposal, while supporting only 20,000 jobs in 2013. Of all the policy options for supporting jobs, upper-income tax cuts most starkly fail cost-benefit analysis.
So what changed between 2012 and 2013 for middle class tax filers? Relatively well targeted fiscal stimulus was allowed to expire, while the vast majority of untargeted, regressive Bush-era tax cuts were permanently continued. And for the vast majority of households earning under $200,000 a year, falling disposable income resulting from tax changes almost entirely reflects the payroll tax cuts’ expiration, not tax increases to help finance health care reform or partial expiration of the upper-income Bush tax cuts.