Preliminary Compromise to Extend Bush Tax Cuts and Cut Payroll Taxes for Workers

December 7, 2010

President Obama announced yesterday that he had reached an agreement with congressional Republicans to extend the 2001 and 2003 tax rates for two years, temporarily reduce the estate tax to 35%, and institute a payroll tax holiday by reducing Social Security taxes paid by workers by 2%. Congressional Democrats have yet to endorse the deal, which will require additional legislation before becoming law.

The proposed payroll tax holiday would reduce Social Security taxes paid by workers from 6.2% to 4.2% for one year. As a result, employees earning $70,000 per year would save $1,400 per year in taxes, while employees earning $106,800 or more per year in wages would recognize a tax savings of approximately $2,100. The tax holiday will replace the Making Work Pay credit, and will not be offset by new revenue raising provisions or other spending cuts. President Obama and other proponents of the payroll tax holiday believe the tax savings to working families will increase consumer spending and further stimulate the economy.

The proposed deal is not the first time the president and Congress have sought to stimulate the economy by cutting Social Security taxes. In 2009, the president signed the Hiring Incentives to Restore Employment Act (HIRE Act) into law, which among other things, provided a temporary 6.2% payroll tax holiday for employers that hired certain unemployed workers. That law, unlike the deal announced yesterday, only reduced payroll taxes for employers, and was intended to reduce unemployment by reducing the cost of hiring new workers. This new framework would not affect employers’ contributions to Social Security taxes.

Given congressional Democrats’ reluctance to immediately endorse the framework announced yesterday, it is possible there may be additional changes to the deal before it finally becomes law. Congress intends to end its lame duck session by Dec. 17, 2010. Thus, a final vote on any legislation is expected on or before that date.