Following the labor market’s lackluster performance in May and June, the administration and some congressional leaders are pushing for an extension or expansion of the payroll tax cut enacted last December, possibly as part of a grand bargain to reduce the deficit. In a primetime speech on the debt ceiling impasse on July 25, President Obama explicitly endorsed extending the payroll tax cut for working families, although no additional economic support appears likely in a debt ceiling compromise—only economically harmful spending cuts. December’s tax cut and unemployment insurance extension reduced payroll tax rates by two percentage points on the employee side and continued emergency unemployment insurance through 2011, but no stimulus has been enacted since. Weak employment growth and powerful economic headwinds should prompt Congress to seek more support for the economy, although job creation should not be contingent on or take a back seat to deficit reduction.

This issue brief highlights three problems with the payroll tax cut and proposes replacing the temporary payroll tax cut with a targeted, partially refundable tax rebate for 2012 to address all three concerns:

• While more targeted than tax cuts for high-income earners, the payroll tax cut is not as targeted and therefore not as cost-effective as other tax cut designs. Targeting tax cuts to working families, who are likely to spend, rather than save, extra disposable (after-tax) income would do more to strengthen the economy while also helping those most in need. Conversely, wealthy tax filers are only benefited by the payroll tax cut, which increases their disposable income more than any tax stimulus for any other group.
• The payroll tax cut provides less help to tens of millions of working families than other tax stimulus measures that are no more expensive. For example, relative to the Making Work Pay refundable tax credit that had been in effect, the payroll tax cut decreased disposable income for many low-income and working families. On net, replacing the MWP credit with the payroll tax cut reduced disposable income for tax-filers earning less than $30,000 by roughly $6.6 billion.
• The payroll tax cut sets a bad precedent for the future of Social Security. A temporary tax credit from the general fund would leave intact dedicated funding for Social Security, which is now partially reliant on general revenue because of the payroll tax cut.