Social Security Payroll Tax Cut – A Temporary Stimulus with Permanent Damage

by  Charles A. Blahous

Published September 23, 2011

As a former colleague of mine has astutely observed, sometimes the most consequential policy mistakes occur because everyone is looking the other way. The President’s
latest “jobs” proposal to extend, and expand, cuts in the Social Security payroll tax is a good example. While nearly everyone has focused on the debatable efficacy of temporary
payroll tax relief as a stimulus measure, few seem to have noticed the severe problems it could create for Social Security itself.

Specifically, the proposal would accelerate a process begun last December: transforming Social Security from what it long has been – a benefit earned by worker contributions –
into an income tax based system more akin to welfare.

As a Social Security Trustee, I believe it is critical both lawmakers and the public have a greater understanding of this effect before the policy is advanced further.

The payroll tax is Social Security’s lifeblood. If it continues to be significantly cut, then only one of two things can happen:  Social Security’s insolvency is accelerated, or;
Social Security must be financed by general (read: income tax) revenues.

Either choice undercuts Social Security’s future ability to operate as it has in the past. So far, the Administration has quietly made choice #2: to convert Social Security into a general revenue-financed program.

The current payroll tax cut, enacted last December, was accompanied by a provision to funnel roughly $105 billion in general revenues into the Social Security Trust Funds. This
year’s “American Jobs Act” aims to cut payroll taxes by a further $240 billion next year alone. The proposed bill would also transfer an offsetting $240 billion in general
revenues into the program to make up for the uncollected taxes. In total, these proposals would make $345 billion of general revenue (income tax) commitments just over 2011-12
to support Social Security benefit payments.

This is not a small change; it would significantly alter the way Social Security is financed.

Consider this: in 2005, President Bush proposed that workers be permitted to invest part of their Social Security contributions in personal accounts. The Congressional Budget
Office then projected that this would result in roughly $323 billion in payroll tax revenues being redirected from the trust funds to personal accounts over the next decade;
critics decried as ruinous what was termed the “transition cost” of personal accounts.

But just two years of the payroll tax cuts proposed by the Obama Administration would shift more payroll tax revenue away from the trust funds than CBO found President Bush’s
proposal would over ten. Even more important, unlike President Bush’s proposal, none of this payroll tax cut would be saved to finance future Social Security benefit payments. The revenue would be “replaced” by new debt issued from the general government accounts.

This proposal should be provoking vigorous opposition from both ends of the political spectrum.

Progressives should oppose it because cutting the payroll tax directly undermines our ability to finance benefits (this is why 61 House Democrats wrote the President on July
21 to express firm opposition to a further payroll tax cut extension).

It also is incompatible with the progressive vision for Social Security’s future. Many progressives argue that the solution to Social Security’s shortfall is to raise taxes by
increasing the wage base subject to the payroll tax . But the case that Social Security might be rescued with significant future tax increases is fatally undermined if
elected officials conclude that the current payroll tax already is too high to sustain during a recession.

For conservatives, the primary problem isn’t cutting payroll taxes, it’s issuing general revenue transfers to the Social Security Trust Funds. Essentially, the proposal would
require that income taxes (rather than payroll taxes) must be raised in the future to redeem Social Security Trust Fund debt and to pay benefits. This would convert Social Security
into a program that requires higher income taxes to fund. It also would convert Social Security into something more like welfare, for which the funding is provided – not by
contributions from all covered workers – but preferentially from those subject to the income tax.

Choking off Social Security’s tax revenue and issuing debt in its place is a dangerously short-sighted policy that would swap, at best, a fleeting gain for potentially
devastating long-term consequences. At the very least, policymakers need to fully understand the stakes, and then ask themselves – and the public – if it’s a trade-off
they’re willing to make.

This is a condensed version of an article by Dr. Blahous previously published by e21. Please click here to view the full article.

[Charles Blahous, a senior research fellow at the Mercatus Center at George Mason University, is one of two public trustees for Social Security and Medicare.]

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