A temporary payroll tax cut extension or a temporary tax cut anything is a mistake. The important issue to understand is what people do with their money during a temporary tax cut. If you know that a tax cut is temporary, you aren’t going to spend your tax savings because you know a tax hike is coming.
Given you aren’t spending your extra income, you are doing nothing to stimulate the economy. In fact, not spending your income is hurting the economy more than if there were no tax cut since we are robbing from Social Security in the future. Giving tax revenue to the government would at least be wasted on some social programs.
A non-reaction to temporary benefits is as clear as day. We are taught this phenomena in high school economics, college economics, business school economics and observe our own actions in the work force. Here are some examples to help illustrate:
Example 1: You won’t stop training your hardest if your next opponent after Peewee Herman is Mike Tyson.
Example 2: You won’t stop studying after your open book mid-term if your final exam is closed-book and accounts for 30% of your grade.
Example 3: Samsung Electronics won’t stop innovating its smartphones just because Apple didn’t release its iPhone 5.
Given you agree with the three examples, why would you ever spend your payroll tax cut income when you know you’ll have to pay more payroll taxes in 2013?
WHAT ABOUT THE REALLY POOR?
Let’s say you earn $20,000 a year in San Francisco or Manhattan. There’ no doubt that you are poor. With a 2% temporary payroll tax cut, you are saving $400 a year, or $33.3 a month, or $16.75 per bi-weekly paycheck in taxes. Because you only earn $20,0000 a year, you live at home with the parents or rent an apartment with a couple roommates. To spend much more than $500 a month on rent doesn’t really work.
$16.75 more income a paycheck should provide a boost to consumption since someone making $20,000 likely spends all their money on necessities. However, if we look at it from a economic stimulus angle, given the bottom 50% of income earners account for just 12.75% of all income, there won’t be as big of a stimulus as desired. Given payroll taxes go up to $106,800 in income, one might be tempted to think that a bigger impact would occur. Again, after a certain subsistence level, people just save any temporary tax cuts for the inevitable increase later on.
One can argue though that the poor would have an even higher propensity to save the temporary tax cut because money is that much more valuable. Sock away for a rainy day and do everything possible to increase one’s income.
A bigger issue lies in those who live outside their means. At every income level beyond poverty, one should be able to spend less than they earn. We must adjust our lifestyles accordingly. Hence, to those who crave a temporary 2% payroll tax cut extension, ask yourself really why this is?
SOLUTION TO THE PROBLEM
We cannot blow a $100 billion+ hole in Social Security for temporary relief when the system is already underfunded. Would you rather pay for this payroll tax cut extension by charging a surtax on income over $1 million like Democrats want? Or would you rather pay for the payroll tax cut extension by freezing salaries of Federal workers and firing more government employees like the Republicans want?
Since I neither make over $1 million a year or am a Federal Government employee, I am objective in saying do neither. Instead, implement a permanent Federal tax decrease for all levels while increasing the breadth of people who pay Federal taxes. A permanent tax decrease until the next President comes along will provide a tremendous signal for companies to start hiring again, and people to spend even more of their disposable income.
For those who make $100,000 or more, have you noticed a $2,136 increase in disposable income since the payroll tax was cut to 4.2% from 6.2%? For those who make under $100,000, have you noticed any increase in disposable income? Are you willing to hurt Social Security more since you don’t think it’ll be around anyway?
Note: My definition of “temporary” is one to two years. The best definition of “permanence” is four to eight years max given the term limits.
Tax Savings Recommendation
Start A Business: A business is one of the best ways to shield your income from more taxes. You can either incorporate as an LLC, S-Corp, or simply be a Sole Proprietor (no incorporating necessary, just be a consultant and file a schedule C). Every business person can start a Self-Employed 401k where you can contribute up to $54,000 ($18,000 from you and ~20% of operating profits). All your business-related expenses are tax deductible as well. Simply launch your own website like this one in under 30 minutes to legitimize your business. Here’s my step-by-step guide to starting your own website.
Updated for 2017 and beyond. Income taxes are set to come down under President Trump. As a result, those who contributed to their Roth IRA or Roth 401k and planned on retiring in 2017 – 2021 had wrong tax expectations.
Photo: Peterhof Palace, St. Petersburg, Russia, FS, 2014.