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On December 23, President Obama signed into law a two-month extension of the temporary payroll tax cut. House Republicans had resisted approving a compromise that had been agreed to by Senate Democrats and Republicans earlier in the month. It was not until December 22 that they relented, at the urging of Senate Minority Leader Mitch McConnell (R-KY), and agreed to the temporary Senate plan.

The legislation extends the expiring rate of 4.2 percent, compared with the regular 6.2 percent Social Security employee payroll tax rate. Employers continue to pay their 6.2 percent share of the overall 12.4% tax.

Had the tax expired, it is estimated that the average American worker would have seen a decrease of $40 per paycheck. In efforts to secure House approval of the temporary extension, the White House mounted a publicity campaign asking, “What can you do with $40?”

Michael Feroli, chief U.S. economist for JPMorgan Chase, garnered significant attention during the negotiations upon reporting that economic growth would be reduced by 0.5 percentage points in the first quarter and 1.5 percentage points in the second quarter of 2012 if the payroll tax cut were discontinued along with unemployment benefits.

Payroll processors are facing a difficult challenge in implementing the temporary extension, which was written to allow only the first $18,350 of wages to be taxed at the 4.2 percent rate. Payroll taxes are only withheld on wages up to $110,100 annually. Without the $18,350 income limitation, employees earning more than $660,600 would be able to get the full year’s benefit of the tax cut before the end of February.

When Congress returns to Washington in January, they must return to debate and decide how, and even if, to extend the payroll tax cut through 2012. They must also decide on unemployment benefits and a Medicare reimbursement rate “doc fix,” both of which were also extended for two months.


Liz Clark

Vice President, Policy and Research


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