In this regard, the President’s Council on Economic Advisers (CEA) has done the Nation a great service in releasing a new report, “Supporting Retirement for American Families.”

Citing a number of “risks” that can “threaten a secure and stable retirement for American retirees,” the CEA says that the estimated share of households that may not have sufficient assets for retirement at age 65 has increased over the last thirty years from 31 to 51 percent.

Put another way, the dream of being able to retire at age 65 without fear of running out of money is no longer available to a majority of American households.

Part of the reason for these gloomy retirement prospects is the decline in the percent of workers covered by traditional “defined benefit” pension plans. The CEA estimates that in 2008,  the most recent year for which data is available, only 20 percent of private sector workers were covered by DB plans, down from almost 40 percent in a little over twenty-five years.

In other words, the employer-managed, annuity-based pension payout, a mainstay for generations of retirees, is disappearing as a more-or-less guaranteed source of retirement income. In its place, of course, is the so-called “defined contribution” retirement plan, depending on employee as well as variable employer contributions, and subject to stock market volatility, interest rates and, most importantly, sufficient employee contributions. As the CEA points out, “the shift to 401(k)-type plans also has transferred substantial risk from employers to workers.”

To be sure, many Americans had hoped that the Social Security safety net would make up for what they were not able to put away in their own nest eggs during their careers. Assuming Social Security remains the same, which may or may not be a reliable assumption, “Social Security benefits can be expected to provide only about 55 percent of lifetime average earnings,” says the CEA.

The conclusion is inescapable: Americans need to make some fundamental work-lifestyle changes to avoid a retirement Hobson’s Choice: one, outliving one’s retirement assets, what CEA calls the “longevity risk”; or two, postponing retirement past age 65.

Among the fundamental changes the CEA report calls for are encouraging Americans to save more for retirement, a daunting task in a weak economy experiencing little wage growth, and making regulatory changes to make “annuitization” more attractive.

CEA defines annuitization as “using liquid retirement wealth to buy a schedule of future income payments,” i.e., “to guarantee a stream of income for life.” Convinced that annuities can protect retirees from the risk of outliving their assets, pension experts in and out of government believe Americans need to shift away from “lump-sum” pension payouts to annuity-based retirement products that guarantee lifetime income.

The CEA report makes a particularly strong case for annuities for women retirees, who have longer life expectancies than men and “who have significantly lower overall retirement income and retirement assets than men, due in part to lower wages and lower rates of full-time employment among women during their working lives.”

The report concludes with a number of regulatory changes in the works to improve the environment for choosing annuities, such as relaxing the Required Minimum Distribution rules (RMD) to make annuities more attractive relative to lump-sum payouts.

Alas, the CEA report does not address the more formidable cultural lifestyle question of age-65 retirement—indeed, what the word “retirement” even means for healthy, vigorous working people. We too shy away from the conundrum: whether historical concepts of working and then “full-stop” at a fixed age of “65” make sense in today’s global economy.

But one must at least recognize that the tectonic changes taking place in the world of work must inevitably also change our concepts of retirement. Perhaps “pushed” by insufficient retirement savings; perhaps “pulled” by the continuing satisfaction of a job well done, many Americans will choose to continue to work, to continue to be productive, to continue to be active, to continue to contribute, either in the same job or in other pursuits.

These Americans over time will redefine retirement in many different and creative ways. One thing we can know for certain: “retirement” tomorrow will scarcely resemble what we understood “retirement” to be yesterday.

Alarm bells went off in Washington DC this week when the Congressional Budget Office (CBO) released its latest estimate of the federal budget deficit. For the fiscal year ending this September 30 Uncle Sam’s budget deficit will top $1 trillion—for the fourth year in a row.

Just to put this number in perspective, if you spent $1 million every single day since the year 1, that’s right, the year 1, $1 million every single day for 2,011 years, you would not yet have spent $1 trillion! To say the least, it’s a very big number and we’ve been racking up trillion deficits for four consecutive years.

The little bit of good news in the CBO report is that the deficit as a percentage of the economy, GDP, has fallen slightly to 7%. The bad news is that it’s still higher than any deficit between 1947 and 2008.

CBO uses what it calls a “baseline” budget to forecast that the annual deficit will decline over the next ten years. The problem is that the baseline budget assumes “current law,” i.e., that Congress won’t change existing laws that are projected to reduce spending and raise greater tax revenue.

Almost no one believes that will actually happen because current law includes (1) allowing all of the Bush-era income tax rate cuts to expire at the end of this year; (2) not indexing the Alternative Minimum Tax (AMT) for inflation; and (3) cutting Medicare payment rates for physician services by 27%.

If, as expected, Congress and the President continue the Bush-era across-the-board tax cuts, or at least most of them, extend and index the AMT to prevent millions of taxpayers from falling into the AMT net and postpone the scheduled cuts in Medicare reimbursements for physicians, the so-called “Doc Fix,” all without corresponding offsets elsewhere, these colossal federal budget deficits will persist for years to come.

In that gloomy scenario, annual deficits will pile up on to the total public debt of the U.S.—now clocked at $15 trillion, to 72% of GDP by the end of this year. And CBO further forecasts that if nothing is done to rein in federal budget deficits going forward “Debt held by the public would climb to 94% of GDP in 2022, the highest figure since just after World War II.”

Even under CBO’s rosy scenario, in FY 2012 the U.S. government will spend $3.6 trillion, take in $2.5 trillion, and borrow $1.1 trillion. Put another way, Uncle Sam will borrow about 30 cents of every dollar it spends.

What to do—

In this sharply polarized election year, this is not the place to get into the politics of deficit and public debt reduction. But whoever is elected President and whoever is elected to the U.S. Senate and House of Representatives in November, Democrat or Republican,  must start 2013 with a commitment to work together to get Washington’s fiscal house in order.

To be sure, politically it will be difficult—as we saw last Summer when President Obama and Congress risked a government default in their clash over the President’s proposal to raise the debt ceiling.

And CBO reminds us that “austerity” programs to cut government spending and raise taxes threaten to slow an already-weak economy and increase joblessness.

But surely the alternative, essentially doing nothing, is a worse choice. Sooner or later buyers of U .S.government debt, including foreign governments like China, will either demand higher interest rates or invest their money elsewhere. This is exactly what’s happening now in Europe, as Greece, Italy, Spain, Portugal and Ireland struggle to find buyers for their bonds at competitive interest rates.

Americans have long been known and admired all over the world for our can-do spirit and ability to take on the most demanding challenges. Trillion-dollar annual budget deficits and a $15 trillion-and-rising public debt burden is not only our challenge; unaddressed, it’s a lasting legacy to our children and grandchildren. Let’s hope Washington can muster the courage to respond.

A top priority for Congress this month will be deciding the fate of the payroll tax holiday.

We saw the preview of this movie in December when lawmakers, unable to reach agreement on a full-year extension of the 2011 Social Security tax break, finally settled on a two-month extension after a bitter partisan debate.

Will the 2% payroll tax holiday be extended for all of 2012? Or will it fall victim to the Republican versus Democrat legislative dysfunction that has imperiled other initiatives?

First, it’s important to note that there’s near unanimous agreement in Washington DC that the payroll tax holiday should be extended through the end of 2012. President Obama supports a one-year extension; most Congressional Democrats support a one-year extension; and most Congressional Republicans support a one-year extension.

The reason a big majority of elected officials support a full-year Social Security tax break is because they think it makes sense economically and politically. The economy is still weak. Unemployment remains way too high. And an economic crisis in Europe could drag the U.S. back into recession. Many economists say the fledgling recovery needs a boost from continuing the payroll tax cut.

Politically it’s a no-brainer. President Obama has positioned the extension as a “tax cut” and suggests that allowing it to expire would represent a tax increase on the middle class. No politician wants to vote for middle class tax increases in an election year.

So why isn’t a one-year extension of the payroll tax holiday a slam-dunk? The answer is that cutting the Social Security tax rate from 6.2% to 4.2% for 160 million workers for a full year adds about $105 billion to the federal budget deficit.

Put another way, while support for a one-year payroll tax holiday is strong, even stronger is opposition to worsening the federal budget deficit—already projected to exceed $1 trillion this fiscal year, pushing the gross public debt north of $15 trillion. With anxious eyes watching the European sovereign debt crisis unfold,U.S.politicians are wary about adding to the deficit at a time when the federal government is already borrowing about 40 cents of every dollar it spends.

In short, a one-year extension of the payroll tax holiday for employees must be “paid-for,” i.e., offset by spending cuts or tax increases elsewhere in the budget. And therein lies the heart of the dispute between Democrats and Republicans: unanimous agreement to extend the tax cut but bitter disagreement on how to pay for it.

Predictably, Democrats will call for raising taxes on high-income earners to pay for the one-year payroll tax break. Just as predictably, Republicans will urge cuts in government spending, specifically by continuing a pay freeze on federal workers. Neither of these ideas will fly in 2012. Does that mean the payroll tax holiday will end on Feb 29?

Few things are certain in Washington DC. No one knows whether President Obama will be re-elected in November. Who can predict what the Supreme Court will decide in June on the constitutionality of healthcare reform? And it’s impossible to say what Congress will do to reduce our government’s titanic public debt, reform the tax code, strengthen Social Security or restructure Medicare. But about one thing we can be certain: Congress will never raise taxes in an election year.

In other words, notwithstanding fair questions about the diversion of funds earmarked for Social Security, whether it really will stimulate the economy or if an extension now will make it difficult to shut off at the end of this year, the 2% payroll tax holiday will be extended for the rest of 2012.

Expect the usual partisan jockeying in the next few weeks as each side accuses the other of needlessly jeopardizing middle class tax relief.. Expect the usual brinkmanship as the clock ticks down and the payroll tax cut nears expiration. And expect the usual White House calls for Congressional compromise in the national interest.

At the end of the day Democrats and Republicans will come together and find a way to pay for a full-year Social Security tax holiday—saving the average worker over $1,000 in taxes for 2012. That’s worth waiting for!

Democrats and Republicans presented the issue as a stark binary choice: cut government entitlements like Medicare or increase income taxes. No wonder the Congressional “Super-committee” failed to reach consensus.

Now comes word from IRS, on January 6, 2012 to be exact, that there’s a third choice: close what’s known as the “Tax Gap.”

IRS defines the “gross tax gap,” $450 billion in tax year 2006 (the latest year for which data are available), as “the amount of true tax liability faced by taxpayers that is not paid on time.” Subtracting out subsequent voluntary or involuntary tax collections yields an estimate of the “net tax gap,” or the “amount of tax liability that is never paid” — a whopping $385 billion in 2006 alone!

While obviously easier said than done, more aggressive efforts to close this gap would alleviate pressure to reduce budget deficits either by cutting spending or raising taxes.

As part of its analysis IRS offers a fascinating chart, distinguishing among three components of the gross tax gap: non-filing, underpayment and under-reporting, with the latter accounting for fully 84% of the total gap. (Tax Gap Map)

Of the total under-reported tax of $376 billion, 63% or $235 billion, is attributable to individual income tax under-reporting, with half of that due to business income tax under-reporting of $122 billion in 2006.

Summing up, the heart of the tax noncompliance problem appears to be not with non-filing ($28 billion) or underpayment ($46 billion) of taxes due, though these amounts are still mammoth, but with under-reporting; and not of employment taxes ($72 billion) or corporate income taxes ($67 billion) but of individual income taxes, particularly business income taxes. Moreover, IRS estimates that between 2001 and 2006 the under-reporting portion of the gross tax gap exploded by 32%, meaning that more and more taxpayers were under-reporting their tax liability.

The good news is that voluntary tax compliance is at an all-time high—about 85%. The bad news, of course, is that this means, according to IRS, that almost 15% “of the estimated total tax liability for 2006 will never be paid.”

What can be done to reduce the size of the tax gap? The answer, says IRS, is that “compliance is far higher when reported amounts are subject to information reporting and, more so, when subject to withholding.” In other words, as President Reagan famously said of a pending nuclear weapons treaty with theSoviet Union, “Trust, but verify.”

 Commenting on the IRS report, Senator Max Baucus (D-MT), chairman of the U.S. Senate Finance Committee, urged that the tax gap be addressed with reform of the tax code:

“This report shows that closing the tax gap needs to be a major focus of tax reform.  An improved tax code that’s simple and fair to all Americans will help close the tax gap, boost our economy and create jobs. In an era when we’re squeezing the federal budget for every dollar of savings, we have to make every effort to recover these lost funds.”

What are we to conclude about the new tax gap analysis? First, we can wish the news media had given more attention to the January 6 IRS report. Public support for more aggressive efforts to close the tax gap might take some pressure off the alternatives of raising taxes and cutting government spending. That’s not going to happen if the public isn’t better informed about this issue.

Second, we can expect more initiatives to expand the scope of information reporting and withholding as Congress and the IRS step up efforts to collect more of what’s owed and not paid. To be sure, requiring more reporting isn’t popular, as Congress learned when it enacted, and later had to repeal, expanded Form 1099-MISC reporting as part of the 2010 healthcare reform law.

Still, it’s likely that IRS will continue to examine ways to cast a wider net of reporting or withholding over financial transactions in an effort to close what is no doubt now at least a $400 billion annual net tax gap. 

In this electronic age, with our gross public debt now soaring above $15 trillion, or over 100% of GDP, and yearly budget deficits over the next ten years forecast to total more than $4 trillion, it’s in everyone’s interests that the $400 billion annual tax gap be closed. Surely that would be better than raising taxes!

IRS on January 3 issued new guidance to employers on the requirement to report the cost of health coverage on employees’ 2012 Forms W-2. In general the guidance gives employers greater flexibility.

Background: The Patient Protection and Affordable Care Act, the 2010 healthcare reform law, requires employers to report the value of employer-sponsored health coverage on employee W-2s for information purposes. There are no tax consequences associated with this mandate.

See the Ceridian Human Resources Legislation Blog for November 1, 2011 for details about the earlier IRS guidance (Notice 2011-28) on this requirement.

In particular, the 2011 guidance specifies (1) that employers must report both employer costs and employee costs, e.g., the employee share of monthly health insurance premiums; (2) that all health costs that are “non-taxable to the employee” must be reported, e.g., the costs of major medical insurance; and (3) that the reporting requirement applies only to individuals who would otherwise receive a Form W-2, i.e., it does not apply to retirees unless they receive a W-2 for other purposes, such as to report payouts under a deferred compensation plan.

The new guidance (Notice 2012-9) clarifies that employers need not report on Forms W-2 the costs of employee assistance plans (EAP), on-site medical clinics or wellness programs, as long as employers do not include these costs in the calculation of COBRA premiums. In some ways the question of possibly having to impute and calculate per-employee costs of EAP and wellness programs for W-2 reporting purposes was one of the biggest concerns of employers with the new reporting requirement.

Also excluded from the reporting requirements are vision and dental plans that are excepted benefits under HIPAA (generally with policies, elections and/or premiums that are separate from those of major medical coverage).  Previous guidance used a somewhat different standard for excluding these benefits:  whether the plan was “integrated into” a major medical plan.  

For group health plan coverage periods that extend beyond December 31, Notice 2012-9 clarifies that employers may treat all coverage as occurring before Dec 31; treat all coverage as provided in the calendar year after Dec 31; or use “any reasonable allocation method” to allocate costs between the two calendar years. In any event, the coverage method must be applied consistently to all employees.

It seems clear from the new guidance and the earlier Notice 2011-28 that employers are not required to report the cost of health coverage on employee Forms W-2 before January 2013—even if an employee terminates during calendar year 2012.

Finally, it’s worth reiterating a suggestion made in the November 1 Blog: consider a special communication to employees explaining the number they can expect to see on their 2012 Form W-2 in Box 12 Code DD. Not only is it important for employees to know the full value of their employer-sponsored health coverage; they should also know that the new number has no effect on their tax withholding—at least for now.

The newly approved measure now goes to President Obama, who is expected to sign it into law shortly.

In an apparent reference to a wage cap provision in the Senate-passed bill that the National Payroll Reporting Consortium had said would be difficult to implement with so little lead time, Speaker Boehner said that the agreement ensures that “a complex new reporting burden is not unintentionally imposed on small business job creators.”

The House and Senate could approve the new legislation, which extends the payroll tax holiday as well as unemployment insurance benefits and physician Medicare reimbursements, under unanimous consent on Friday, Dec 23, and send the bill to the President for his signature.

Lawmakers have pledged to negotiate in January an extension of the 2% payroll tax holiday for all of 2012.

Senate Democratic and Republican leaders, unable last week to hammer out a compromise on how to pay for President Obama’s proposed extension of the 4.2% employee payroll tax rate for all of 2012, had negotiated a two-month extension through February 29, assuming that the House would go along and work out a final agreement on a full year extension in February.

Meanwhile, the National Payroll Reporting Consortium (NPRC), a nonpartisan organization of payroll service providers, said the Senate-passed bill might be unworkable as written. The group pointed to a provision in the bill establishing an $18,350 cap on wages to which the 4.2% payroll tax rate would apply during January and February. Wages paid in those months above $18,350 would be subject to a 6.2% payroll tax rate.

In a letter to House and Senate leaders NPRC urged Congress to reconsider the wage cap, saying there was insufficient lead time to program and test payroll systems to implement the $18,350 wage cap. Given the now very short time to implement any change, they advised Congress at this late date to focus on payroll tax rates and not make major changes in withholding requirements.

Today’s acrimonious House debate and vote underscores the wide philosophical chasm that separates Republicans and Democrats over issues of economic policy and federal budget deficits. While media attention has focused on the two-month versus twelve-month debate, the real issue has been and remains how to “pay for” the full twelve month cost of a 2% payroll tax cut: $105 billion.

Republicans and Democrats, including President Obama, almost unanimously agree that new laws must not worsen the federal budget deficit or public debt—which is the sum total of all previous annual deficits. In short, new government spending or tax cuts must be “paid for,” i.e., offset by spending cuts or tax increases elsewhere.

And therein lies the real difficulty Congress faces in extending the 2011 payroll tax holiday through the year 2012: how to pay for it?

First some cost numbers: President Obama’s original stimulus package, proposed in September, included expanded payroll tax cuts for 2012 for both employees and employers, with an eye-popping price tag of $240 billion. Congress balked at the President’s “pay for”—capping individual tax deductions at 28%.

The fallback was a simple extension of the 4.2% employee-only payroll tax holiday for all of 2012 at a cost of $105 billion. Predictably, Republicans and Democrats deadlocked over the pay-for: Democrats wanted to increase income tax rates for high-income households; Republicans wanted to extend a pay freeze on government employees and make other spending cuts.

Complicating matters, Congressional leaders tried to make the one-year payroll tax holiday extension more palatable by packaging it with an extension of unemployment insurance and a delay in scheduled cuts in reimbursements to health care providers under Medicare, the so-called “Doc Fix.” While smart politically, the larger package raised the pay-for stakes to $190 billion, ironically making the climb to consensus even steeper.

Unable to agree on how to pay for the one-year payroll tax break and the other provisions and with the Christmas Holidays looming, Senate Republican and Democratic leaders and the White House did the best they could—they settled for a two-month extension of the 4.2% payroll tax holiday, UI benefits and the “Doc Fix” at a total cost of “only” $32.4 billion. The pay-for was easier too: an increase in fees for Fannie Mae and Freddie Mac housing loans. No controversial tax increases or government spending cuts.

The good news was that payroll tax rates for 160 million workers would not increase to 6.2% in less than two weeks. And that translates into real money: a tax saving during January and February of about $165 for someone earning $50,000 per year; $330 for the $100,000 earner.

But the bad news was continued uncertainty about payroll tax rates. Even assuming the House of Representatives went along with the Senate’s two-month extension, Congress and the President would need to revisit the whole debate again in two months.

Today’s vote shows that Senate leadership assumed too much—the House of Representatives was not prepared to go along with a two-month extension. Indeed, the House earlier in December had voted for a one-year extension of the payroll tax holiday, adding an amendment to force the President to make a go/no-go decision on the Keystone XL oil pipeline project.

Now the House of Representatives and the U.S. Senate have passed conflicting bills: the House version extending the 4.2% payroll tax cut for all of 2012 and the Senate’s extending it for only January and February. If Republicans and Democrats are unable to resolve their differences, especially on the real issue of the “pay for,” the employee payroll tax rate will rise to 6.2% on January 1—in less than two weeks.

No one can predict the outcome of the payroll tax cut debate. Congress could decide to extend the 2011 4.2% tax rate for two months, three months or longer or, if they remain deadlocked, allow payroll tax rates to revert to 6.2% on January 1. We can only hope that Republicans and Democrats, like old Ebenezer Scrooge of A Christmas Carol, will have a change of heart at this special time of year and resolve this issue soon in the interests of 160 million workers and America’s payroll and HR professionals.

The basic issue is whether the one-year 2% employee payroll tax holiday in effect for 2011 will be extended, ended or expanded.

While at least 4 scenarios could play out on Capitol Hill, about one thing we can be certain: the employee payroll tax in 2012 will not revert back to 6.2%. As confident as we can be that the sun will rise in the morning, we can be confident that Congress will not increase payroll taxes in a presidential election year. A 2% “increase” in the payroll tax rate next year would translate into a $900 tax hike for the average household. It’s not going to happen.

So why the delay? What are the likely scenarios? When will all this be resolved?

To answer the last question first, this issue will be resolved by December 16—to give payroll systems time to put new payroll tax withholding in place by January 1, 2012.

Why the dilly-dallying? Perhaps the main reason why this issue is percolating into December is that back in September President Obama proposed, as part of his “Jobs for Americans Act,” not just an extension of the 2011 payroll tax holiday but a major expansion to stimulate the economy.

The “Pay-For”—

Further complicating things is that, because annual federal budget deficits are forecast in the $1 trillion range and the government’s public debt has topped out at a record $15 trillion, any tax cut must be “paid-for” by offsetting spending cuts or tax increases. It’s estimated that extending the 2% payroll tax holiday through 2012 would cost the Social Security Trust Fund a minimum of $120 billion—which of course the U.S. Treasury would make up for out of general tax revenue.

President Obama’s proposal to “pay-for” an expansion of the payroll tax holiday by capping income tax deductions at 28% was dead-on-arrival on Capitol Hill, so Congress needs to find some other way to offset the budget impact of any 2012 tax holiday.

Competing Scenarios—

What are the possible scenarios that will play out in the next two weeks?

First, President Obama and Congress could agree simply to extend the 2011 2% payroll tax holiday through 2012. This is the most straightforward scenario and, most importantly, insures that worker payroll taxes don’t rise starting on New Year’s Day.

Second, it’s possible that Congress will agree to the President’s September proposal to expand the payroll tax cut to 3.1% instead of 2%.

The two-fold difficulty with expanding the payroll tax cut is that, (1) it requires an even larger “pay-for” since the budget cost could easily reach $150 billion; and (2) it punches a bigger hole in the Social Security Trust Fund, already on shaky solvency ground. It’s also not clear that a 1.1% difference in payroll tax withholding, spread out over perhaps 25 biweekly payroll periods, is going to have much impact on consumer spending.

A third scenario is that the payroll tax holiday, either 2% or 3.1%, could be extended to employers, as President Obama has proposed, in order to encourage new hiring. The President’s proposal was to set the employer Social Security tax at 3.1% for 2012, but only on the first $5 million in wages paid—to target the incentive at small business. In any event, expanding the payroll tax cut to employers significantly increases the cost.

Fourth, a new, high-powered employer payroll tax holiday could be enacted, again as the President proposed in September, by creating a special 100% employer Social Security tax “refund” on up to $50 million of increased wages paid in 2012 over 2011, for a maximum employer payroll tax break of over $3 million for 2012. More complicated to administer, a one-year employer payroll tax refund tied to a wage increase ceiling would break new compliance ground and probably put the total package cost in the $250 billion range.

A Prediction—

The competing scenarios hopefully explain why Capitol Hill democrats and republicans have delayed action on the President’s proposal to extend and expand the payroll tax holiday. But turning a page on the calendar to the month of December should remind lawmakers that time is running out to decide.

The 2011 holiday was enacted on December 17, 2010—at the “last minute” from a payroll compliance standpoint. It’s now time for Congress to shift from “Park” to “Drive” and resolve this question.

Mindful of the risks to the Social Security Trust Fund and the huge impact even modest payroll tax cuts have on the federal deficit, it’s likely that Congress will be cautious about expanding the Social Security tax holiday; and extra cautious about extending it to employers.

All this suggests that Scenario One above is most likely to play out in the next two weeks. Congress can always surprise; President Obama could insist on 100% of his September proposal—3.1% for employers and employees and a full refund on increased wages up to $50 million. That would be the all-too-familiar gridlock scenario and mean more procrastination.

On the other hand, no one wants payroll taxes to go up starting in January and a reasonable compromise would be to extend existing law for another year. That’s a sensible scenario for the Holiday Season and sure beats endless dilly-dallying.