Congress appears likely this week to approve some form of an extension of the 2011 payroll tax cut that put $1,000 more into the hands of the typical U.S. wage earner in 2011. This is a sensible way to provide economic stimulus, but unless Congress suddenly begins behaving like an adult, risks a dangerous game of ping-pong with the country's most important retirement and safety-net program.
Lower-income Americans pay little or no income taxes. Yet everyone who works pays Social Security payroll taxes, and they take a big bite out of middle-class incomes. When times are hard, cutting payroll taxes is a logical way to provide some relief to working Americans. The tax cuts amount to small income increases each pay period, and are likely to be spent and not saved. They thus provide a steady, if modest, economic stimulus. Given the continued weakness of the economy, extending the cut makes sense. There's also a small matter of national elections in 2012, and neither political party wants to be seen as cutting paychecks next year.
In 2011, the employee's share of Social Security payroll taxes was cut to 4.2 percent from 6.2 percent. Employers continued to pay 6.2 percent, with both taxes being paid only on the first $106,800 in wage income received by an employee. Employees and employers also each pay a 1.45 percent tax to help fund Medicare. There is no income limit on that tax. Self-employed workers must pay both shares of these taxes, amounting to a sizable total of 15.3 percent of their wage income.
It's not clear what Congress will do next week. Choices include extending the 2011 Social Security payroll tax reduction, increasing it, and also giving employers a similar break on their share of payroll taxes. Medicare taxes would not be affected.
The big immediate conflict in Congress is how to pay for these cuts, however large they may be. There is no tolerance on either side of the aisle for a stimulus that also raises federal deficits. The debate is over which other programs and people are going to pay the bill, through some combination of spending cuts, higher fees, and higher taxes on wealthier Americans. If there are easy decisions here, I haven't seen them.
One easy call, however, is to resist using a change in Social Security payroll taxes as an occasion to change the way Social Security is treated with regard to the overall federal budget. This may seem a cosmetic aspect of the current debate. It is not.
Social Security largely operates outside the federal budget and the political bickering that has been passing for governance in recent years. It has its own dedicated revenue stream and does not tap the U.S. Treasury for any spending needs. It has built up a $2.5 trillion surplus, largely in anticipation of the growing numbers of baby boomers who are beginning to claim Social Security benefits. It was always expected that this surplus would shrink over time, but it is clear that the steep recession has accelerated this decline. There clearly is a need to make some changes in the program to restore its long-term funding and spending balance. But there is no crisis in Social Security and no reason to scare the daylights out of the more than 50 million Americans who depend on the program's retirement and disability benefits.
The 2011 payroll tax cuts were expressly matched by repayments to Social Security from general government funds. As a result, the financial condition of the program was not affected by the payroll cuts. Still, it is common to see critics of the program who have either forgotten this provision or prefer to ignore it. They argue that Social Security has added to the federal deficit because of the payroll tax cuts. Following this logic, the prospect of additional cuts in 2012 further weakens the perceived separation of Social Security from other deficit issues. It becomes just another program, and one that might become subject to frequent changes to meet broader fiscal and political goals.
In reality, payroll taxes were cut because they offered the easiest and most direct way to put more money into the hands of working people. Providing an equivalent amount of stimulus via income tax cuts would have been a nightmare and taken a long time. Sending stimulus checks to Americans would have generated a huge one-time payment that would not have had the same continuous impact on supporting consumer spending. No additional bureaucracy was required to implement the program.
The payroll tax cut, in other words, was not about Social Security at all. It just used Social Security taxes as the easiest vehicle to deliver the stimulus. Turning the cuts into the basis for changing program benefits or the way it's funded is a bad idea. Unfortunately, with all the problems in Washington these days, a deficit of bad ideas is not among them.