White House could protect middle class from tax hikes if deficit talks falter

The White House has the power to temporarily protect taxpayers from middle-class tax hikes even as upper income rates rise if Congress does nothing and all of the Bush-era tax rates expire in January.

Experts and lawmakers alike agree that Treasury Secretary Timothy Geithner has the power to adjust how much is withheld from paychecks for tax purposes — for all taxpayers or just for some.

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By doing so, Geithner could ensure paychecks reflect the White House position that wealthier taxpayers with annual income higher than $250,000 see their taxes rise. Geithner at the same time could leave withholding tables where they are for the middle class, ensuring those workers don’t see a higher cut from their paychecks.

“If we were to, say, go over the cliff and the rates go up, he could modify those withholding tables such that the average employee out there would not effectively see any more or less taken out of his paycheck,” said Bill Hoagland, senior vice president at the Bipartisan Policy Center.

The tactic could buy Washington precious time to strike a tax agreement without pinching the economy, but it carries substantial risk. If the administration miscalculates where rates end up, tinkering with withholding could morph tax refunds into hefty bills.

“If you want to go down this route, you had better be pretty sure that, at the end of the day, you know what the outcome is going to be,” said Joseph Minarik, senior vice president and director of research at the Committee for Economic Development. “If you guess wrong and taxpayers have to write checks next April…they’re not going to be happy.”

Under the law, it is Geithner’s responsibility to set withholding tables that employers use as a guide for how much to keep from paychecks, and to do so in a way that is “most appropriate” to carry out current tax law.

But with the White House and Congress knee-deep in haggling over tax rates, many are wondering what “most appropriate” might mean if rates jump at the beginning of 2013, especially if Washington seems to be on the cusp of some sort of tax deal.

Geithner could opt to not adjust withholding to reflect the new rates, either in anticipation or hope of a new deal reinstating lower rates.

Experts believe Geithner could even go so far as to adjust withholding to reflect the White House’s preferred policy — higher rates on the nation’s top 2 percent of earners and lower rates on everyone else. In fact, Minarik said the president could even use withholding as leverage in negotiations with Republicans if it came to that, using the tables to argue he is protecting the paychecks of the middle class.

Lawmakers on both sides of the aisle acknowledge Geithner has this power, even if they hope to be productive enough to make it irrelevant.

Sen. Chuck Schumer (N.Y.), the No. 3 Democrat in the chamber and a member of the tax-writing Finance Committee, told reporters this week that he hoped a deal would be in place before the end of the year, making the withholding option unnecessary.

But Sen. Ben Cardin (D-Md.), also a Finance member, told The Hill that, if push came to shove, he hoped Treasury would only manipulate withholding tables if Congress and the White House seemed close to a deal.

“You’ve got to have some reason to withhold, because it causes a huge hardship if you don’t have realistic withholding schedules,” Cardin said.

Cardin also noted that Democrats and Republicans are in general agreement that tax rates should stay the same for family income under $250,000 a year, so keeping current withholding tables for those taxpayers could be an option, if necessary.

“If there’s optimism as to how that’s going to become part of a deal, then OK,” he said.

Sen. Orrin Hatch (Utah), the top Republican at Finance, essentially agreed with Cardin, saying he believed that the administration had broad powers on the tables and that he hoped modifying them would be a last resort.

“That would be the hope,” Hatch said, when asked if Treasury should only freeze tables if a deal was imminent. “There’s no doubt in my mind they can do it if they want to.”

One downside to the strategy is that it has a limited shelf life. If withholding is kept lower than the rates in the law, that means the tax bill at the end of the year will be that much higher. So if no deal emerges to bring rates back down to the level reflected in the withholding, it will be up to taxpayers to make up the difference.

“I could see this working for basically a quarter,” said Hoagland.

By taking a look at withholding tables, the administration also would only be able to influence a portion of the tax hikes in the "fiscal cliff." Withholding rates, for instance, have nothing to do with the alternative minimum tax, the estate tax or taxes on capital gains and dividends, all of which are also expected to spike or hit many more taxpayers without a fiscal-cliff agreement.

Still, tinkering with withholding tables is not unprecedented. In 1992, President George H.W. Bush lowered withholding rates in an effort to stimulate the economy by increasing the size of people’s paychecks.

While both parties agree the Treasury has the power to control withholding, it remains an open question whether Geithner himself is looking to use it.

The Treasury Department declined to answer questions about withholding, but pointed to comments Geithner recently made that seem to throw cold water on the notion.

“Don’t look to that as a solution to this problem,” he told Bloomberg’s Al Hunt. “Don’t over-interpret what that authority gives me. Again, it does not give me the authority to ... let them avoid making some decisions on rates and policy.”

A GOP aide on the Hill also pointed to those comments in saying it was “clear that withholding tables need to reflect the rates.”

“While he has this authority, he knows he has this authority, it’s not something that they seem to be at least considering,” said Hoagland.