The Invisible Elephant: The Payroll Tax Cut
The federal income tax is paid almost entirely by upper income people—in 2007, almost 40% of federal income tax came from the top one percent of the income distribution, while the bottom 60% contributed just over 1% of the total (Figures from the CBO). The payroll tax, on the other hand, is a fixed percentage up to a maximum. The result is that the lowest quintile of the income distribution, which on net pays less than nothing in federal income taxes, pays about 9% of its income in payroll taxes, including (as the CBO does) both employee and employer share.
The bill held the top rate of the income tax at 35% instead of letting it go back to 39.5%. It reduced the employee's share of the payroll tax from 6.2% to 4.2%, reducing the total (employee share plus employer share) from 12.4% to 10.4%. A little arithmetic should convince you that the percentage reduction in the payroll tax is more than the percentage reduction in the top rate of the income tax. The change in the payroll tax in the bill is for only one year; we will have to wait and see whether it, like the Bush tax cuts, ends up lasting for longer than that.
While the actual incidence of the payroll tax—who really pays it—does not depend on whether it is collected from the employer or employee, it does depend on the elasticity of the supply and demand for labor, which determine how much of it ends up as a decrease in wages, how much as an increase in the cost of labor—a point ignored by the CBO in its analysis of tax incidence. Further complications would include other features of the bill—its effect on tax rates on dividends, inheritance, and the like. A full calculation would be complicated and the results would depend on assumptions, in part arbitrary, about who actually ends up paying each tax.
What is clear is that a large and under reported part of what the bill contains is a cut in the one part of the federal tax system a significant part of which is paid, at least directly, by people in the bottom sixty percent of the income distribution.
That is the elephant in the room.