The Agenda

The Payroll Tax Holiday as an Opportunity to Rethink the Payroll Tax

I found Wessel’s conversation with Holtz-Eakin and Bernstein stimulating (I had no choice but to make that pun):

 

An alternative to the Obama approach, Mr. Holtz-Eakin said, would be to reduce and revamp the corporate income tax, “get serious about entitlement reform” and take off the table the possibility of a major financial crisis resulting from unrestrained U.S. budget deficits. Noting that business investment is among the few bright spots in the economy, he argued for trying to get more of it.

Mr. Bernstein countered: “The idea that somehow you’d stimulate more hiring, because that’s really what we need here, by increasing the return to business investment doesn’t seem to match the reality of the moment.”

But the two analysts did agree on a few things. Both favor spending on public infrastructure, although Mr. Bernstein emphasized the job-creating possibilities, and Mr. Holtz-Eakin said the projects should be justified on the merits not as stimulus. And both supported the extension of unemployment benefits for up to 99 weeks and the president’s proposal to continue and expand a payroll-tax holiday that is set to expire this year. [Emphasis]

I am more sympathetic to Holtz-Eakin, yet it must be said that the political case for his approach is very challenging. 

I’ll also add that though Holtz-Eakin has embraced the president’s call for continuing and expanding the payroll-tax holiday, the decision should give us pause for at least one reason: the premise of the payroll-tax holiday, as I understand it, is that it will allow us to bring demand forward to sustain a given level of consumption, to preserve current employment levels if not expand them. The trouble is that if a recovery is not on the horizon, we may create a political dynamic in which Social Security benefits are decoupled from the payroll tax and it becomes very hard to end the payroll-tax holiday. One could imagine a scenario in which Congress creates a new revenue stream to pay for Social Security benefits, e.g., a package of Pigovian taxes on carbon emissions, etc. Yet the ostensible goal of a carbon tax is to reduce carbon emissions, thus making a carbon tax a potentially unstable revenue source. Note, for example, how declining gasoline tax revenues has prompted a call for a vehicle miles traveled tax as a more robust solution. 

Some years ago, Kenneth F. Scheve and Matthew J. Slaughter published an essay in Foreign Affairs, “A New Deal for Globalization,” that suggested a new approach to raising revenue for Social Security:

A New Deal for globalization would combine further trade andinvestment liberalization with eliminating the full payroll tax for all workers earning below the national median. In 2005, the median total money earnings of all workers was $32,140, and there were about 67 million workers at or below this level. Assuming a mean labor income for this group of about $25,000, these 67 million workers would receive a tax cut of about $3,800 each. Because the economic burden of this tax falls largely on workers, this tax cut would be a direct gain in after tax real income for them. With a total price tag of about $256 billion, the proposal could be paid for by raising the cap of $94,200, raising payroll tax rates (for progressivity, rates could escalate as they do withthe income tax), or some combination of the two. This is, of course, only an outline of the needed policy reform, and there would be many implementation details to address. For example, rather than a single on-off point for this tax cut, a phase-in of it (like with the earned-income tax credit) would avoid incentive-distorting jumps in eªective tax rates.

This serves as a reminder that the extension of the payroll-tax holiday might serve as an opportunity to rethink the structure of Social Security and the Social Security payroll tax itself. 

Another approach might involve scrapping the payroll tax and the personal income tax and replacing both with an X tax, i.e., a graduated consumption tax that could achieve the distributional benefits of the Scheve and Slaughter proposal while also improving the tax treatment of capital income. 

Almost a decade ago, Megan McArdle proposed the “Jane Galt tax plan,” which includes elements of the more recent Jonathan Berk proposal and that unified the payroll and personal income taxes:

 

1) Get rid of all our poverty programs, except those aimed at the disabled, and temporary unemployment assistance, and institute the negative income tax. That is to say, the system should be continuously progressive, from a steep negative rate of up to 100% on very low earners, gradually declining until it zeroes out around $28,000 a year, and then rising gradually until it maxes out around 35% on the top brackets.

2) Eliminate FICA and pay for Social Security and Medicare out of general revenue. It’s time to stop pretending it’s a pension system, when there are no assets in the “trust fund”

3) Eliminate the corporate income tax

4) Eliminate the special treatment for capital gains. All income should be taxed at the same level, regardless of its source.

5) Eliminate all deductions. Period, end of statement. No mortgate, student, child, etc. All causes are equally worthy in the eyes of the person who possesses the deduction; it is a waste of our time as a nation to sit around arguing about who deserves what.

6) Just say no to the Value Added Tax. In theory, it’s a good tax. In practice, because it is extremely hard to tell what proportion of the price of anything represents the tax, it removes the good and natural pressure upon tax rates.

7) Get rid of the estate tax, and tax the capital gains on whatever is sold.

Naturally, I disagree with some of the provisions of the JGTP. But I do think the idea of merging the payroll tax and the personal income tax has much to recommend it. Earlier this year, there was a rumor that George Osborne, Britain’s Chancellor of the Exchequer (and a politician I admire), was considering a merger of the income tax and national insurance contributions, the British equivalent of our Social Security and Medicare payroll taxes. As Richard Wachman of The Guardian reported, there was considerable anxiety over the psychological impact of a merger:

 

Mike Warburton, tax director at Grant Thornton, the accountancy firm, said: “The plan is a good one in principle as it can’t be right that people’s earnings are subjected to two different taxes. But the issue is politically charged because an amalgamation of the two taxes would mean basic rate taxpayers would see their income tax jump from the current rate of 20% to 32%, to take account of the 12% NI rate that comes into force on 5 April. Psychologically, that could be difficult to swallow, so changes would have to be very carefully explained.”

Higher rate taxpayers would see their rate jump from 40% to 52%. Over the years, Conservative and Labour governments have increased national insurance to avoid being accused of raising personal taxes.

Warburton said the reality was “there is no separate national insurance pot that goes towards paying unemployment benefits or the state pension; NI is all part of general taxation”.

Basically, a merger of the payroll tax and the personal income tax, for all its virtues, strikes at the heart of what Will Wilkinson memorably called the “noble lie” at the heart of the Social Security system:

[T]he Social Security status quo embodies a government-perpetuated deception designed to generate its own political support by misleading voters into believing that their payroll taxes entitle them to later benefits. The architects of Social Security created a structure and accompanying rhetoric that were specifically intended to encourage the false belief that the system provides a kind of insurance, similar to private insurance based in contract and property, and therefore involves a binding entitlement to benefits.

However, there is no justification for this deception on contemporary liberal grounds. The persistent intentional misrepresentation— the “noble lie” — embedded in the structure and language of the Social Security system is in fact antithetical to the ideals of transparent government, open democratic deliberation, and equality among citizens — ideals at the core of contemporary liberal thought.

Having criticized Rick Perry for calling Social Security a “Ponzi scheme,” it is perhaps surprising that I endorse Will’s characterization of the “noble lie” embedded in Social Security. I’d argue that the Ponzi scheme charge is a very specific charge, and that it shouldn’t be confused with the more general claim that there are problematic and deceptive aspects of how the Social Security program was initially sold. 

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