The Agenda

Cutting Payroll Taxes for Over-62 Workers: A Killer App?

Andrew Biggs of AEI, one of America’s most productive and insightful policy analysts, has an op-ed in the Wall Street Journal building on an idea he introduced as one of the co-authors of AEI’s contribution to the Peterson Solutions Initiative:

Unlike other taxes, the work incentives presented by Social Security are a function of the tax workers pay in a given year minus the future benefits those taxes entitle them to. For younger or low-income workers, this “net tax rate” is low or even negative. For near-retirees, however, little or any new benefits are earned in exchange for taxes paid, making Social Security a clear disincentive to work.

This creates an intriguing possibility:

Obviously, reducing or even eliminating the payroll tax for older workers would lower Social Security revenues. But increased labor-force participation would raise non-Social Security tax collections. The budgetary question is how these balance out.

Using the standard Social Security models developed by the Policy Stimulation Group, I estimate that eliminating the 12.4% payroll tax for workers at age 62 would reduce annual Social Security revenues by roughly 2.2%, or about $16.2 billion in 2012 tax collections.

Using Eric French’s parameters, it would increase the overall labor supply by around 1.4%. The average 62-year-old working full time in 2010 earned around $58,800, implying a federal income-tax rate of about 15%. Adding the 2.9% Medicare tax and a 4.4% average state income-tax rate, total non-Social Security revenues would rise by around $18.3 billion, of which the federal government would collect about $14.7 billion. Thus higher non-Social Security revenues compensate for much of the payroll tax cut. (Higher benefits earned by later retirements have no significant impact on these estimations.)

Meanwhile, the gains to individuals and the economy could be substantial. Working one additional year would boost average private pension income by almost 5%. And all Americans would benefit from the extra goods and services that older workers could provide.

I find this idea particularly attractive because I’ve long been drawn to the idea of age-dependent labor taxation. Matthew Weinzierl of HBS, for example, has argued that tax cuts for the young could yield significant economy-wide returns. 

There is a political challenge with these proposals: a payroll tax cut for over-62s will almost certainly be characterized as pandering or special-pleading, despite its logic; pairing tax cuts for over-62s with tax cuts for under-25s might engender resentment from the middle-aged.

Regardless, I’m convinced that there is a strong case for a steep cut to the payroll tax for over-62s, if not outright elimination. The Republican presidential nominee should give this idea serious thought.In an ideal world, we’d address larger revenue concerns through a comprehensive consumption-oriented tax reform. And that’s one of my concerns: I worry that Romney may have boxed himself in too early on taxes, but we’ll see.


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