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By now, most people have probably received their first paycheck of the year and have seen the effect of the expiration of the payroll tax holiday.  As part of the economic stimulus packages during the throes of the Great Recession, the powers that be decided that giving a temporary break would help the economy.  Most Americans contribute 6.2% of their paycheck toward the Social Security Fund, and this was cut to 4.2% throughout 2011.

For someone making $52,000 per year, this resulted in additional take home pay of roughly $1,000 per year, with the hope being that Americans would spend that money, injecting spending into the economy.  Spending which, at that point, had been dramatically slowed.

At the end of 2011, the payroll tax holiday was extended for an additional 12 months, so Americans now had two years of extra spending money.

This is good and bad.

The pros

Here's a couple of reasons that the tax holiday was a good idea:

  • It gave Americans more spending money – For many people (myself included), the 2% holiday was the only raise that they saw in their paycheck for multiple years.  At the time, many companies were cutting people, and if you were lucky enough to keep your job, many salaries were cut.  This squeezed paychecks, and an extra $40 or so per paycheck would certainly help many families pay the bills or pay off some additional debt.
  • It may have helped us out of the recession faster – This is up for debate, but the fact is that we did eventually work our way out of the worst of the recession, and the spending power given by this 2% cut is largely believed to have contributed, at least in part.

The cons

Here are a few reasons why it could be argued that the payroll tax may not have been such a great idea:

  • It didn't help people who had already lost their jobs – The tax gave people a break from paying some of the taxes on their paycheck.  That's all fine for people who have a paycheck, but if you were one of the millions of people that lost their jobs, you weren't getting a paycheck, and the tax holiday didn't benefit you at all.  Granted, they had other ‘measures' which were supposed to address this, such as countless extensions to unemployment benefits, but regardless, there were a good percentage of Americans who didn't see benefit from this at all.
  • The cut was temporary, but people didn't see it that way – I can't tell you the number of people I've seen complain on Facebook about how their paychecks went down (even though it technically was not a tax hike).  The fact is that everybody should have seen it coming, but two years is a long time to forget about the fact that the holiday wasn't going to last forever.  Many people got used to the 2% additional income and baked it right into their budget.  If they budgeted their paycheck, if they did their household budget, over a two year period, that money was included.  To cut it out became a big shock.
  • Our economy is still fragile – I find it laughable that a huge piece of the negotiations that centered around ‘going over the fiscal cliff' was to make sure that taxes didn't go up for middle class Americans, with the logic being that the economy couldn't afford that.  Yet, every middle class American who collects a paycheck just saw their income go down.  In fact, extending the payroll tax holiday for additional time was a non-starter on both sides of the political aisle (probably the one thing both parties agreed on, go figure).  It's interesting that the same politicians who argued about the effects of tax rates going up and the impact that would have on the economy addressed the fact that by letting this expire, surely spending will be effected, leading to probable economic impact.  In six months when growth slows or certain sectors start seeing a slowdown, will anybody acknowledge the fact that diminished spending power might have a direct relation?
  • It added to the budget deficit – There were no spending cuts to match the decrease in revenue that resulted from this ‘holiday', so the long and short is that this added to budget deficits.  Budget deficits that stand today at over $16 trillion dollars and are growing at over a trillion dollars per year.  Yikes.

My verdict

I personally never liked the idea of the tax holiday, not because I didn't like the idea of getting more money, but because I knew that it was simply another method of kicking the can down the road, and that we would eventually have to let the ‘holiday' run out, at which point it would be painful.

Once it was re-upped for a second year, I felt that the prudent way to act should have been with a clear and gradual exit strategy.  Rather than extend it and let it simply expire at some point (which is what happened), they should have set an end date, and also phased it out.  Maybe half a percent every six months, which would have given people a little more opportunity to get used to the reduction versus an all in one approach.  I knew that this was never going to happen, because people would have seen it as getting hit three times instead of one.

So, my verdict is that I feel they messed up twice.  They messed up by enacting it in the first place, then they messed up by letting it expire all at once after such a long time of having it in place.

How we handled it

I haven't gotten a raise for several years, so I'm not going to lie, the extra money came in handy.  For us, we handled it such a way that we never actually saw a bump in take home pay.

The first year.  In 2011, our health care premiums were going up by an amount that would have impacted my take home pay by about 1%, so half of the 2% was accounted for right off the bat.  We also increased my 401(k) contribution by 1%, going from 10% to 11%.  With that, my take-home-pay was about the same.

In 2012 they kept our health care costs the same, so when they extended the holiday, doing nothing kept our pay the same (since once again, we did not get a raise).

Now that it's going back up, our paycheck is definitely affected.  We actually made the switch to a High Deductible health plan with a Health Savings account.  The cost of this is actually less prior to making any HSA contributions.  However, the net difference for us after the premium decrease and the 2% Social Security increase is only about $40 per paycheck.  This means that, assuming we keep everything the same, we would only be contributing $960 toward our HSA plan, a number that would fall very short of my hoped for amount.

Had the 2% holiday not expired, we would have been able to contribute quite a bit more.

The obvious answer is to decrease our retirement contributions, since we used part of that as funded by the tax holiday.

But, I don't want to do that.  If we do it will be a method of last resort.

For now, we'll tough it out.  It's been hard not getting a raise for as long as it's been.  Every y ear, costs of goods have gone up.  Costs of health care premiums have gone up.  We've had two kids in that time frame, so costs there are way up.  In other words, the same paycheck four years ago went a lot further than it does today.

But, we still find a way.  And, it's worth it.

For now, we'll keep the retirement contributions the same, and as far as making sure our HSA is funded, there are several options.

I'd written in the past indicating that we had some flexibility in our emergency fund.  Bleeding off 10% of that could provide a comfortable padding in our HSA account and at least help ensure that we are keeping it well funded.  In the past, we've also contributed a portion of our tax refund toward paying down debt, with one of my goals being to pay the mortgage off before our kids started college.  Since re-financing in 2011, that's already built in, so while it would be nice to advance pay some debt, extra payments are something I could postpone and still be comfortable with.

What do you think of the payroll tax holiday now that you had two years of living with it and the band-aid ripped off all at once?  Would you have handled anything different on a macro level (agreeing with it from the standpoint of the economy) or on a micro level (how you handled it within your household)?  What do you think the impact of the expiration will be on the economy?