In a somewhat stunning turn of events, the House Republican leadership has decided to add $100 billion to the US deficit by passing a 10-month extension of a Social Security payroll tax cut without finding offsets to pay for it.
This comes within 24 hours of hyper-criticism (much deserved) of President Obama’s budget. (One of my favorite parts of the Obama budget is the use of a peace dividend stemming from ending the wars in Iraq and Afghanistan. Sounds great, until you realize that both wars were not paid for and therefore there is no honey pot of money to spend.) The move was apparently done to take away Democratic criticism that Republican intransigence would negatively impact 160 million Americans. The strategy appears to create a stand-alone bill for the payroll tax cut, then have another bill for the extension of unemployment benefits and a fix to the Medicare reimbursement rate for doctors.
At the core, the payroll tax cut is one of the worst possible tax cuts to use because it not only worsens the viability of Social Security, but also it’s a tax that is almost impossible to avoid paying. For the House Republicans, they may be able to salvage some fiscal credibility by ensuring that the “Doc fix” and jobless benefit extension are both paid for via spending cuts/tax hikes. Given that Republicans have caved on the payroll tax, it may be impossible to convince the rank and file members that the leadership will stick to a position of fiscal prudence on these other issues. Moreover, this move blurs the lines between the two parties and certainly will raise Tea Party questions over why to support the Republicans in a national election. It may help drive the call for Ron Paul to splinter-off, run as a third party candidate and effectively hand the election to President Obama.
Most importantly, this sets up a year-end train wreck for solving thorny, but critical issues on taxes for the lame-duck session of Congress. The ending of the Bush tax cuts for all taxpayers, the ending of corporate tax extenders and the ending of the payroll tax cut for 2012 will all be on the potential docket. This includes the capital gains tax rate going from 15% to 20% and the dividend tax rate going from 15% to ordinary income tax rate. The latter change would likely call into question all those equity market strategies that were based on high dividend payouts from companies as a means of creating income during a low interest rate environment. Along with the FOMC keeping rates at zero, this will be another way the government punishes domestic savers.