August 6, 2011

The Biggest Middle Class Tax Hike in U.S. History Debuts On Jan. 1, 2012 (Guest Post)

By Bruce Krasting

There is one aspect of the final debt deal from DC that took me by surprise. I was convinced the 2% reduction in payroll taxes would be extended through 2012. 

Not only did I think there would be a one year extension of the existing holiday; I forecast that the subsidy would actually be increased. I was steered in the wrong direction by the Boss himself. On July 11th Obama stated:

"I want to be crystal clear. Nobody has talked about increasing taxes now. Nobody has talked about increasing taxes next year. We’re talking 2013 and the out years."
In the same press conference he added:
"[cuts in FICA payroll taxes] would be a component of this overall package."
I don’t think the President said these words without having some sort of understanding with Speaker Boehner. Two weeks ago an economic stimulus was part of the plan. Today there is nothing. I think I understand what may have happened--When push came to shove, the FICA holiday got shelved. That had to happen to get a deal done. Why? Because we are so broke we can’t afford the stimulus.

The deal that was reached to get the debt ceiling raised results in a 2012 reduction in expenses of only $21b. This comes to 1/8th of a percent of GDP. Meaningless. But if the tax holiday had been rolled for another year it would have resulted in $120b of additional 2012 expenses (net -$100b). This amount (plus the interest on it) would have wrecked the economics of the overall plan. So what was originally hailed as a good idea (by both sides) was shot down in the end.

I think this is an important development. It points to two things--The first is that we are economically vulnerable and we have no traditional responses. The second is that we are going to hit a very big economic wall on January 1, 2012.

As of the first of the year, taxes on payrolls are going up by 2% across the board. This will suck $10b a month out of consumer’s pockets. I think it will prove to be a critical $10b.

The reason that the current stimulus was directed at FICA taxes is that this was the most progressive way to provide some relief. Those same individuals/families (average income of $37,000) will be hurt the hardest when the rates go back up. For a family with two average incomes, the tax increase comes to $1,500 a year.

Will that make a difference? You bet it will. Toward the end of the month many families will get squeezed. (Good luck with your Wal-Mart stock when that starts to happen.)

The $120b in increased taxes will translate to a direct reduction of consumer spending. As a result, GDP will take a hit. The move to FICA taxes will, by itself, reduce GDP by 1/2 to 3/4%. That is a very big deal.

One would have to be blind not to recognize that the economy is currently approaching stall speed. And now we have introduced another big headwind. That wind will be blowing in our face in less than five months.

The debt limit crisis has forced the political leaders in DC to throw out the Keynesian playbook. In the end, this might be a good thing. But it is going to hurt like hell this winter. Sometime around February we are going to hit a very cold and solid wall. The economy could tank.

Possibly some readers can answer these questions:
  • Did Obama completely crater on this?
Absolutely! Not only did he fold on his base (middle class) he put a landmine in the economy for 2012. Exactly the worst thing for a guy to do when running for office.

  • Did Boehner also get outmaneuvered?
I think he was forced to fold on the FICA stimulus. I’m convinced he wanted to extend the tax holiday. A bad economy is bad for Republicans too.

  • Is our government functioning properly?
Absolutely not! We may have just made the same (similar) mistakes that were made in 1937. I think all of Washington has folded on their responsibilities.

About The Author - Bruce Krasting had worked on Wall Street for 25 years--"For 25 years I woke up thinking, "What am I going to do today to make some money in the market". I don't do that any longer. But I miss it."  Nowadays, Bruce blogs about his take on financial events at Bruce Krasting.  (EconMatters author archive here.)

The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.

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