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November 12, 2002

How About Killing the Payroll Tax?

Avedon Carol wants to know what Max, Brad and I think of the idea proposed by Matthew Yglesias to make killing the payroll tax the next big "Democrat idea."

Bad idea.

As Max will argue more strongly than me, when you add together taxes paid and benefits paid out, social security is one of the most progressive parts of the budget. It not only creates a safety net for the poorest elderly, it covers the non-elderly disabled. In fact, such disability SSI payments grew tremendously in the 1990s-- more than 5.4 million people receive SSI payments and more money is spent that way than on food stamps and unemployment insurance.

And because the disability payments are tied up with old age pensions, they aren't subject to the same easy attacks as "welfare" and other line items paid for with the regular income tax. That's a political reality that can't be ignored. If anything, this indicates that the left should be encouraging more programs to be integrated into Social Security, just as we should encourage expanded national health care as part of Medicare.

BTW all the worries about a "crisis" in social security due to baby boomer retirement is bullhockey. See my "Saving" Social Security: Invest in Immigrant Children, not the Stock Market.

But there are some serious reforms of the payroll tax we should pursue. As Matt and Max point out, you only get taxed on the first $80,000 of wages. Bill Gates stock dividends don't get taxed at all and rich professionals actually pay a smaller percentage of their income in payroll taxes than middle class folks.

So the simplest reform would be to include every dime of wages plus all other income in calculating taxes owed to social security, then cut the rate for the middle class. Removing the tax cap on wages alone would raise $425.2 billion over five years. That alone could either end any fears about social security's solvency or be used to cut the payroll tax significantly. Estimates are that this could cut the payroll tax by 1.53% for everyone else.

Add in taxing non-wage income of the wealthy for social security and we could enact serious payroll tax reform.

But the last thing progressives should do is abandon the one untouchable tax-and-spending program in the budget.

Reform the payroll tax. Don't kill it.

Posted by Nathan at November 12, 2002 08:35 PM

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I agree, big time, that payroll tax reform would be great. One of Reagan's sleaziest tricks was paying for his tax cut by jacking up the regressive payroll tax.

But couldn't reforming the payroll tax have bad consequences, if done wrong? I mean this: If I'm not mistaken, your SS benefits are calcuated in terms of how much you've paid in taxes. Lower taxes=lower benefit level. So reforming tax might lead to lower pensions.

A simple way to solve this would be to say "All income is subject to payroll tax, but only the first $80k is to be taken into account when calculating benefits." I don't know how palatable that would be though. The Republicans would try to whip up anger among those who were getting their taxes raised and not their benefits--and they'd fudge the income levels like mad, in order to make that class look larger than it is.

Anyway, thoughts?

Posted by: Matt Weiner at November 13, 2002 10:09 AM

I believe the system has always tied benefits to wages earned, not to taxes paid. When the 1983 Social Security bill hiked payroll taxes, it didn't automatically raise benefits. And benefits were raised in the past without hiking payroll taxes.

So it would be quite possible to cut payroll taxes without cutting benefits.

And setting a limit on a maximum social security monthly check is a given in such a proposal.

Posted by: Nathan Newman at November 13, 2002 10:21 AM

I'm afraid this is confused. You speak as if killing the payroll tax would kill the supported programs (rather than funding them differently), and emphasizing the tail (SSI) rather than the dog (OASI), then you propose replacing the payroll tax with what is essentially an income tax ("every dime of wages plus all other income").

There is a fundamental problem with the payroll tax -- ordinary wages are declining as a % of GDP, and have done so for about 50 years, and are expected to continue. There is a fundamental virtue -- the tax is borne substantially by employers, rather than employees (contrary to what most folks believe and many economists blithely/lazily agree). But this virtue hs a dark side -- the PT suppresses domestic employment in favor of imports, and would do moreso if we jacked it up to compensate for falling wage shares or rising disability/retirement costs.

The analysis is complex, but I favor replacing the PT with a more explicitly progressive tax structure more conducive to domestic production.

As a minor point, benefits are calculated neither on wages nor on taxes paid, they depend primarily on covered wages, i.e., wages up to the ~$80K "ceiling".

Posted by: RonK, Seattle at November 13, 2002 11:46 AM

Well, I just looked at Matt's proposal, and he's proposing eliminating the payroll tax AND the "mythical" trust funds. (I moved the quotation marks.)

Bad, bad, bad idea. The trust funds are like Christmas clubs--we're putting money away now that we'll need to spend later. Yes, it's just a matter of internal accounting, but that internal accounting is important.

And I think that's what's important about having a separate tax earmarked for Social Security--it lets us keep track of how we're doing with respect to the idea of saving our SS taxes for the program itself. Without the idea that your SS taxes are paying for SS, it will be just another welfare program.

That doesn't mean the SS taxes have to be payroll taxes. And none of it is economic--it's all a matter of perception. But perception is important.

(OK, that was written quickly, and probably isn't very well thought out. Fire away.)

Posted by: Matt Weiner at November 13, 2002 01:36 PM

Money we pay into Social Security is still taxable, did ya'll know that? Most voters don't.

If you pay $2000/year into Social Security, you then have to pay income tax on that $2000 you never got.

I'd love to see the Democrats suggest rolling back the Bush tax cut for fatcats and making SS payments tax deductible. Everybody would get a tax cut who currently works, but on a percentage basis the fatcats would get very little.

Posted by: William Burton at November 15, 2002 03:14 PM

Re making payroll tax deductible

In the case of Joe Blogger vs Felix Fatcat (both married filing jointly in this illustration for tax year 2003) ...

Joe Blogger deducts an extra $2000 (out of $26144 in wages), reducing his taxable income in the 15% bracket, saving $300 (1.1%).

Felix Fatcat deducts an extra $9917 -- OASDI thru $87000, and Medicare for all earnings -- (from earnings of $350K), reducing his taxable income in the 38.6% bracket, saving $3828 (1.1%).

If Felix is a self-employed professional, he'll do even better.

Payroll tax reform is more complicated than it looks, from every conceivable angle.

Posted by: RonK, Seattle at November 16, 2002 03:44 PM

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