Payroll tax, jobs and Social Security

One part of the jobs program that President Obama will be presenting this week is an extension of the payroll tax reduction. The extension is widely supported by Congressional Democrats, as well as labor unions and other progressive forces. But some activists and economists are opposing an extension, claiming that it will undermine Social Security. What should be done?

The two percent solution

In December 2010, as part of the deal extending federal unemployment benefits, and extending the Bush tax cuts for the rich, there was agreement on a 1-year reduction in the payroll tax. Workers and employers each pay 6.2% of earnings into the Social Security system. The December deal reduced the workers’ share by 2 percentage points.

For workers, this meant an immediate boost of 2% in their take-home pay. Much of the increased take-home pay gets spent, increasing total demand for goods and services, and therefore increasing economic activity and jobs. The EPI estimates about 1 million jobs were gained, although this may be on the high side.

The payroll tax reduction, along with unemployment benefits for long-term jobless, expire at the end of this year. The President will propose that these programs be extended.

Criticisms of the payroll tax reduction

There were many valid criticisms of the payroll tax holiday:

l  It is less progressive than other alternatives — a worker earning $20,000/year gets only a $400 benefit, while a worker earning $100,000 gets $2,000 back. For the same total cost, it would be better to give a flat amount, e.g., $1,000, to every worker regardless of income.

l  Tax breaks in any form are less effective in creating jobs than targeted spending. The same amount of money going to help state and local governments avoid layoffs and cutbacks, and to extending infrastructure and youth jobs provisions of the expiring stimulus act, would have provided more social benefits and generated more jobs.

l  With take home pay raised by 2% at the expense of the federal government, it is possible that employers felt less pressure to increase wages this year. If an employer gave a 1% raise this year, and otherwise would have felt compelled to give a 2% raise, it means that in effect, half of the payroll tax reduction went to the employer instead of the worker. This would tend to undercut whatever stimulus and job-creating effect the payroll tax reduction had.

Tax Holiday and Social Security

Some opposed the original deal, and are opposing a renewal, on the grounds that it weakens Social Security. They make two arguments.

1. It has been claimed that reducing workers’ taxes by two percentage points means that much less revenue for the Social Security system, causing the trust fund to be used up faster. This is incorrect. According to the Congressional Joint Committee on Taxation, the Social Security and Railroad Retirement trust funds “will receive transfers from the General Fund of the United States Treasury equal to any reduction in payroll taxes attributable to this provision.” In other words, the U.S. treasury makes up the difference — about $90 billion per year. So the cut in the payroll tax adds to the overall federal deficit (which is true of any tax cut or stimulus spending or bombing Libya or any other spending), but it does not affect the Social Security trust fund.
2. It has been argued that in the past, Social Security has been entirely funded by the payroll tax on workers and employers. Having the federal government use general funds for part of the funding is a dangerous precedent. It will be difficult to reverse, and will give credence to Republican arguments that Social Security benefits must be cut to ease pressure on the overall federal spending.

From an accounting viewpoint, the payroll tax reduction has no impact on the Social Security trust fund.

From an economics viewpoint, maintaining and even increasing Social Security benefits should not be a problem any time in the future. The only economic threat to Social Security is the danger that the overall economy will continue in a depression with high unemployment for an extended period.

From a political viewpoint, saving Social Security is part of the class struggle over the attempt by the richest of the rich to steal our retirement to finance their own tax breaks. The struggle includes confronting many phony economic arguments, but the payroll tax issue doesn’t look to be a tipping point in that fight.

Conclusion

The payroll tax reduction is not the best way to help struggling workers and create jobs. But at this point, letting it expire would do real economic harm. Even if the estimate that one million jobs are at stake is off by a factor of two, expiration could contribute to 2012 being even worse than 2011 for jobs.

Politically, extending the payroll tax reduction in its present form is the most likely proposal to pass. Opposing the measure could divide and divert the growing national movement demanding much more advanced programs to create jobs and rebuild America. It could play into the hands of the Republicans and tea party who would like nothing more than a defeat for Obama administration and rising unemployment during an election year.