Senators Propose Extending Payroll Tax Reduction

June 24, 2011

Claiming that it would increase the pace of the U.S. economic recovery, a group of Senators including Senators Harry Reid (D-NV) and Chuck Schumer (D-NY) on Wednesday called for new stimulus measures to be included as part of the ongoing debt ceiling debate. One of the main proposals discussed was an extended and expanded temporary payroll tax deduction.

As part of last December’s budget deal, a portion of employees’ Social Security payroll tax payments are suspended, reducing the rate from 6.2% to 4.2%. This payroll tax holiday is reducing federal revenue by an estimated $111.7 billion. The senators’ proposal would extend this deduction for another year.

Although it is clear that economic recovery is not complete, the proposal may not succeed in its intentions. Generally, these frequent “temporary” changes to the tax code also increase uncertainty and threaten to create economic distortions within the economy.

If officials really want to encourage economic growth through tax policy changes, they should pursue comprehensive tax reform. Broadening the tax base and lowering rates would reduce administrative and compliance costs, discourage tax avoidance, and eliminate unjustifiable distortions.

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A tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities.

The tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates.