Addicted to Crisis: How the Payroll Tax Deal Explains Washington

The two-month payroll-tax-cut extension is the latest reminder that making policy for astoundingly short periods of time is embarrassing for government, confusing for businesses, and bad for everyone

615 obama sign office desk.jpg


Every December, Congress faces a dwindling calendar and a pile of unfinished business. And every year, stuck somewhere deep in that pile, sits a packet of expiring tax provisions that show up again and again. The result: a second, quasi-permanent tax code that costs billions of dollars and slowly distorts the processes of building a coherent federal budget.

The hotly debated payroll-tax deduction, scheduled to return to its full 6.2 percent after Dec. 31, is just one of 67 expiring tax provisions--worth $300 billion or more--that are waiting to be swept into a behemoth package of renew-this-now legislation that President Obama signed just before his holiday vacation. Such last-minute measures have become a perennial problem as lawmakers fight over which tax programs to extend. The usual answer: all of them.

The culprit is the lawmakers' shrewd manipulation of the budget process. Increasingly, they prefer to impose a short time frame on tax provisions that would otherwise look too costly or controversial to append permanently to the nation's tax code. This way, they can offer popular benefits, such as a tax credit for research and development or a deduction for mortgage insurance, while valuing the cost over a year instead of a decade. Members of Congress can thus keep pet legislation on the books without having to justify the long-term expense. It also lets them play down a provision's true costs, because the Congressional Budget Office applies easier rules in estimating the costs of short-term programs.

But the unintended costs of this legislative evasion are mounting, according to Ryan McConaghy, the director of the economic program at the centrist Democratic think tank Third Way. Among voters, the repeated renewals create a perception of permanence. "Once you have a benefit going and it gets popular, it is always tough to roll back," McConaghy said.

Some of these annually renewed provisions now rank among the most expensive tax programs in the federal code. In 2010, lawmakers approved an $858 billion package to extend the Bush-era tax cuts and rein in the alternative minimum tax for another two years and also to continue a multitude of tax provisions--including a payroll-tax "holiday"--for one year. That was many times the cost of the largest permanent tax expenditure in 2008: $131 billion to exclude employer contributions from medical insurance premiums and care.

Even worse, these supposedly temporary revenue measures obscure the U.S. fiscal outlook, because CBO number crunchers aren't permitted to take political reality into consideration when they make their projections. Every year, budget and deficit forecasts are adjusted and altered from a baseline that, by design, ignores benefits due to expire, even if everyone on Capitol Hill knows that Congress will keep those benefits alive. "According to the law, CBO identifies their baseline, but everyone still knows that [other changes are] going to happen," McConaghy said. "It muddies the budget picture."

The 2001 and 2003 tax cuts, notably, took full advantage of this polite fiction. The overwhelming cost of the combined rate cuts made them arithmetically problematic as a permanent change to the code. Republican leaders quickly restructured the legislation to include a mandated end of life. But under intense pressure from taxpayers who've grown accustomed to the lower rates, the tax cuts were renewed at the end of 2010 for another two years.

If these things keep happening, watch out. A 2010 study by economists Alan Auerbach of the University of California (Berkeley) and William Gale of the Brookings Institution, which the Congressional Research Service has cited, projected that public debt would approach 600 percent of GDP by 2085, assuming the continuation of current law, and 900 percent if the Bush-era tax cuts are made permanent.

Not that a temporary change in taxation is always, or inherently, a no-no. Trying something before making it permanent lets lawmakers--in theory, at least--test the effectiveness of a measure or address a near-term shift in the economy. Short-term stimulus efforts, such as the payroll-tax deduction, have been used to address the immediate needs of the struggling economy.

"The more transparent the cost of the programs are, the greater potential of Congress taking seriously the drain on the finances of the country," said Gerald Yin, a former chief of staff at the Joint Committee on Taxation. "I want [lawmakers] to see the numbers every day, every week" so they will reconsider the costs.

The problem is that the system has rarely worked that way in practice. "Temporary" has increasingly become code for "permanent" and "politically expensive." Most of the extenders that Congress approves every December have strong and vocal supporters who view the expiration of long-standing benefits as a de facto tax increase. Companies and individuals see the savings and favor deepening the deficit to losing their tax break, especially in a shaky economy.

The rising deficit is putting pressure on these temporary measures and forcing frequent battles over paying for the extensions. Debate over spending has made lawmakers scale back demands for how long each short-term program may be extended. And, in the case of the Bush tax cuts, lawmakers continue to use the recurrent expiration deadlines to secure expensive breaks for high-income earners.

Ducking the long-term implications of short-term tax decisions may be more of a problem next year. Nobody in Washington will have a chance to ignore the near-simultaneous expiration of the Bush-era tax cuts and the onset of statutory budget reductions now that lawmakers couldn't cut the federal deficit on their own. Not to mention the scheduled expiration of dozens of lesser-known but beloved tax goodies.

Add to that an election that could see both chambers of Congress and the presidency change hands and--conceivably--the path might be cleared for a fundamental reform of the federal tax code. That, experts say, would bring an end to the annual renewal of the tax code's "temporary" fixes. At least until Congress finds something else that it wants to fix.