The Payroll Tax Cut Extension: How It Affects The Average American

01/04/2012 01:03 pm ET Updated Mar 05, 2012

In an act of astonishment, House Republicans agreed to a two month extension of the payroll tax cuts before they were set to expire on Dec. 31, 2011. Congressional stalemates appear to have been the norm in 2011, which included the budget deficit fight in the summer of 2011. These political stalemates have increased the nation's sense of dissatisfaction with Washington.

The deal provides for a two-month extension of the social security tax cut of 4.2 percent from the original rate of 6.2 percent. The extension continues the tax cut for over 160 million workers and saves approximately $1,000 per household. The extension also included the following:

  • Keeping the current rates for Medicare payments to doctors;
  • Extending the federal benefits of those who have experienced long term unemployment;
  • Maintaining same payroll processing structure so small businesses would not have to upgrade their accounting systems

House Republicans and Democrats have stated that the agreement is a victory for low and middle income families and not for their respective parties. Rep. Greg Walden (R-OR) said the stalemate was not about politics. So the stalemate was about principles, not politics? What about sound economic principles? Is this really a victory for low and middle income families? The cool thing about accounting (yes, there is a cool thing about accounting) is that with any tax break, there needs to be an increase in revenue in order to make up for the tax break or shortfall. From a business perspective, you either increase revenue or reduce expenses... or you go out of business. Government unfortunately is a different economic animal. This is how Congress intends to pay for the payroll tax extension:

The payroll tax cut extension is said to cost approximately $33 billion over 10 years and will be paid for by increasing the fees charged to mortgage lenders by Government Sponsored Entities (GSE) like Fannie Mae and Freddie Mac. The fee increase is expected to raise around $33.7 billion over 10 years. Private companies, like mortgage lenders, are in the business to make money. In other words, the increased fees charged by Fannie & Freddie will be passed on to the very same low and middle income families that are said to be helped by the tax cut. Americans are basically moving money from their left pocket to their right pocket... with Congress as the conduit.

As the average American wonders how this will affect him or her, Congress continues to put off the resolution of important issues. One such issue is the Social Security debate. Regardless of what side of the aisle you're perched on, dwindling social security funds affect majority of Americans. The payroll tax cut lowers the amount of social security taxes that are being paid into the coffers. In other words, less social security taxes means less social security checks paid out to the nation's seniors. The social security system isn't a savings or investment account. Monies coming in from taxes generally go out in payments. Many retirees will rely on their social security and as the Baby Boomers reach the age of 65 resulting in further financial strain. The good news is that you have time to use strategies to alleviate your dependence on your social security. Here are a few of them:

  • Utilize employer 401(k) or retirement plan matching -- most employers will match up to 6 percent of your contribution to the company retirement program. This equates to free pretax dollars that can grow your retirement account. A $100 monthly contribution can be a $200 contribution with the employer match.
  • Tax Yourself -- people have a better success rate with saving if they use direct deposit. Ask your HR department or payroll processor to deposit 3 percent to 5 percent of your paycheck in a fee-free savings account.
  • Fund Your IRA before April 15, 2012 -- You can contribute up to $5,000 to your IRA (Individual Retirement Account) for 2011 and you can reduce your 2011 taxes.