The GOP’s Payroll Tax Opportunity
Dec 10, 2012, Vol. 18, No. 13 • By JAMES C. CAPRETTA AND YUVAL LEVIN
Now, as the president and congressional leaders negotiate over how to steer clear of the tax hikes and spending cuts looming at the beginning of 2013, the future of the payroll tax is very much up in the air. A few Democrats (like Chris Van Hollen, on the House Budget Committee) have expressed support for extending the cut, but others (including House Democratic leader Nancy Pelosi) have expressed opposition, and the administration has been noncommittal. The opening is there for Republicans to become the champions of extending the cut, and thus the champions of all 155 million American wage earners whose tax burdens would be kept from rising—including millions of middle-class workers not much affected by the income tax debate.
So why the reluctance? A sizeable faction in the GOP is skeptical of the economic value of cutting payroll taxes, especially if it is only done temporarily. But this concern ignores some key facts about the current economic moment. For starters, all the grave worry about the “fiscal cliff” centers on the fact that it would involve too much fiscal consolidation too quickly. Most economists believe that the $600 billion in tax hikes and spending cuts scheduled to take place in 2013 would push the economy back into recession. The payroll tax is a key component of this problem. At $95 billion, the sudden jump in payroll taxes would be second only to expiration of the Bush-era tax rates in terms of the burden it would place on the American economy.
Moreover, conservatives have argued for years that one crucial key to improving long-term growth is reducing marginal tax rates as much as possible in order to avoid undermining not only the incentives to save and invest but also the incentives to hire and work. The payroll tax is a direct tax on employment and work. If it were lower, employers would have stronger incentives to hire, and workers would have greater incentives to work longer and earn more.
The primary criticism of extending the payroll-tax cut, however, is that it would undermine Social Security and weaken the incentives for fiscal discipline in the program. Social Security is effectively financed through payroll-tax receipts deposited into the Social Security Trust Funds. At moments (such as now) when the trust funds are projected soon to be depleted, the only remedy before Congress has been to scale back benefit commitments, increase revenue, or both. When the payroll tax was cut in 2011 and 2012, however, neither party wanted it to come at the expense of the trust funds. So the lost payroll-tax revenue was covered with direct payments from the general fund of the Treasury. This precedent has some in both parties worried.
Conservatives fret that the door has been opened to papering over Social Security’s long-term deficit with similar transfers from the Treasury in the future, thus reducing pressure for reform. Liberals, on the other hand, worry that introducing general-fund financing into Social Security will weaken political support for the program. Up until the past few years, the amount of money collected by the payroll tax was at least as great as the amount paid out in benefits by the program, thus creating the perception among workers that they had “earned” their benefits. If Social Security were partially financed out of the Treasury’s general fund, the program might begin to be viewed more like other government spending programs, including welfare.
Neither of these concerns should hold Republicans back from embracing an extension of the payroll-tax cut. The idea of earned benefits in Social Security was always a fiction. Today’s beneficiaries are not paid back money they put into the system but are paid with money that today’s workers pay in taxes. And money raised through the payroll tax is not put aside for Social Security. It is spent by the Treasury on other things in return for a formal commitment to pay benefits when they come due. The payroll tax is essentially used as a source of low-interest borrowing for the rest of the government, undermining fiscal discipline more than reinforcing it.
If the idea of a trust fund with its own balance sheet once served as an impetus for reform (as it surely did in the late 1970s and early ’80s), today it serves only to shield Social Security from the pressure for reform that results from the federal government’s overall fiscal imbalance (which is greater than that of the Social Security trust funds). It is the reason why Democrats can say (as White House press secretary Jay Carney did last week) that Social Security, which is the largest line item on the federal government’s badly imbalanced budget, “is not a driver of the deficit.”