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Why the Payroll Tax Extension is Useless

By on January 2, 2012 in Tax

Why the Payroll Tax Extension is UselessRight before Christmas Congress put on their smiling faces to deliver a gift to the American people: a two month extension of the payroll tax cut. There was a long, hard fought, and public battle in the media by both sides of the aisle to extend or to kill the tax cut.

While many celebrated this extension, it really doesn’t matter in the long term. Here’s why.

Why the Payroll Tax Cut Extension Doesn’t Matter

It’s great to get a bit of extra money in your pocket, but this payroll tax issue won’t help or hurt you in the long run. Here are three key reasons why.

How Much Extra In Your Pocket?

The payroll tax cut dropped the tax rate from 6.2% of your earnings to 4.2%. You’re saving 2% on each pay check. If the average American earns around $45,000 per year, that 2% cut would save you at most $900 over the course of a year. The two month extension? Saves the same family $75 per month.

Granted, $75 is nice to have, but it won’t drastically change your financial situation. (Or, if it does, you are relying on a tax law to keep you afloat and need to make further financial adjustments.)

Is There a Significant Deficit Impact?

Part of the debate in Congress was a further extension of the tax cut would essentially be more deficit spending. By deciding to not collect the full tax we are having to borrow that 2% difference on every check. That’s definitely bad, but how big of an impact would the added tax had on the deficit overall?

By itself, not really. However, Congress never tackles one issue alone, and also agreed to extend unemployment benefits and stops a reduction in Medicare payments to doctors.

The math is further complicated by a new addition to mortgages purchased by Fannie Mae and Freddie Mac that this legislation requires. For every $200,000 in mortgage principal borrowed, a fee will increase $15 per month. If you get a mortgage that falls in this area, part of the savings you just received from the payroll tax cut extension just disappeared.

The numbers aren’t clear, but some have thrown out the overall cost of the combined legislation to add about $200 to $500 billion to the deficit. That’s only about 1.3% to 3.3% of our current debt. While not insignificant, it truly is a drop in the bucket.

Congress Should Focus on Huge Issues

Giving taxpayers a brief bump in the pocketbook – one they are already used to – is nice, but there are much larger issues at hand that must be addressed.

The United States government is currently $15 trillion in debt – and that number is growing every single second of every day. As a country we are spending much, much more than we earn every month. Just as with personal finance, government finance must cut spending and increase income to get out of the current debt problem. Having a small amount of debt is fine – you are leveraging your money – but when a large percentage of GDP is covered by debt we have a problem.

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