In trying to make a silk purse out of a sow's ear, the president's advisors added a payroll tax holiday to the tax agreement they were working out with the Republicans last weekend. After giving away Bush's estate and income tax cuts for the uber rich, they sought to get something back, and, they told me, the Republicans would not agree to the refundable aspects of the Making Work Pay Tax Credit, the president's own signature tax cut initiative included in the 2009 stimulus package.
Earnest White House and Treasury staff members have been assuring various interest groups all week that in negotiating a payroll tax reduction of some 32 percent (a 2 percentage point cut from the worker's share of 6.2 percent), they meant no harm to the long-term finances of the Social Security system. Not only is the higher tax rate proposed to be reinstated (without requiring a vote) after a year, but the Social Security Trust Fund is made whole by a transfer of like amounts from general revenues all during the year, so the Fund will even earn the same amount of interest it would have from payroll tax receipts. As they came under increasing pressure from Social Security advocates, the White House released a letter on Friday from Social Security's chief actuary confirming that the Trust Fund would lose no money.
But the Trust Fund is not actually the advocates' main concern. They're more worried about being able to get the payroll tax up again in 2012 after the emergency situation of a tanking economy has hopefully passed. The central problem is a political one. Already some Republican members of Congress have said that a move back to 6.2 percent will be seen as a tax increase (in fact, close to a 50 percent increase), always unpopular, especially in an election year. If the payroll tax isn't raised, squeezing the money out of general revenues every year when Social Security would be competing with all other spending could be extremely difficult, and pressure for benefit cuts would grow. As of now, the American people don't mind paying the payroll tax: 86 percent said so in a recent survey, so giving them a short-term gift they don't particularly want and, in exchange, putting the program that is their life support at risk is just a bad deal.
I have no doubt that the staffers working on this who have spoken with me mean well. They carefully explained to me that they set the size of the payroll tax reduction so that a person earning $20,000 per year would get a $400 tax cut, the same as under Making Work Pay; that required a 2 percentage point tax cut, which when aggregated to all workers paying the FICA tax is some $112 billion. They were pleasantly surprised when the Republicans agreed to that large a tax cut, which constitutes significant stimulus to the economy since much of that extra disposable income will be translated into demand for housing, transportation, meals, and so on.
While a payroll tax cut would be good at getting small amounts of money into each paycheck, it has some other less desirable features as stimulus. Most importantly, a lot of it goes to high-income people who tend to hold onto added income. Everyone earning more than $106,800 per year (the maximum salary on which workers will pay FICA tax in 2011) will get the full $2,136 reduction, including members of Congress, the president, Wall Street traders, and top managers across the country, and many of these high earners will save rather than spend their extra income.
Under Making Work Pay, every person with earnings of at least $6,451 got the maximum credit of $400 and married couples with earnings of at least $12,903 got the maximum couples credit of $800 (whether one or both worked). These credits started phasing out at $75,00 for singles and $150,000 for couples, and no one earning more than $95,000 ($190,000 for couples) received anything at all. For low-income people who owed no federal income taxes, the credits were refundable, so an eligible person or couple received a check from the government. With a payroll tax reduction, every individual making less than $20,000 and every married couple earning less than $40,000 (roughly 40 million workers in total) would get less than they would under a Making Work Pay extension, but the payroll tax rebate at least gives them something back. Since Republican opposition to refundability would have left many low-income people with nothing had the income tax been used as the delivery mechanism, the payroll tax cut seemed like the better alternative to White House staffers concerned about low earners.
What is most troubling now is that even though the risk to Social Security has been pointed out to the White House, these same staffers continue to insist that the rebate must take the form of a payroll tax cut delivered in every paycheck in 2011 and that other alternatives won't do. For example, Congressman Brad Sherman has suggested issuing a rebate check to each worker early in 2011 for 2 percentage points of the 6.2 percent FICA tax each paid in 2010. Dollar-wise, that's essentially the same as giving workers 2 percentage points in 2011. Sure, there will be more workers in 2011 (if we're lucky and get some employment growth), but they could be included by issuing rebate checks early in 2012 based on what they earned in 2011. Also, even though research shows that lump sums aren't spent as readily as smaller amounts, the portion spent after 3-6 months is quite substantial. And since we will need stimulus all through 2011, the difference between these two distribution systems can't be so great as to make the Sherman alternative totally unacceptable to the White House -- when it has the very important advantage of never reducing the payroll tax rate to 4.2 percent and so never having to figure out how to get it back up to 6.2 percent. While Sherman's proposal virtually mimics the payroll tax cut, Nancy Altman, co-chair of Social Security Works and a leading advocate against the payroll tax rate cut, suggests a more progressive alternative, one that would likely increase the stimulative value of the tax cut -- an identical lump sum to every worker who paid FICA tax. Such a method would direct more dollars toward lower earners (the average benefits would be on the order of $800) and therefore generate more spending.
Many people are becoming aware of the dangers to Social Security from a cut in its tax rate -- phone calls, organized by groups like NOW and the National Committee to Preserve Social Security and Medicare, have been pouring into Congress and the White House. For sake of Social Security and the millions of women and men who depend upon it, I hope Congress will be able to negotiate a change in the agreement. Since the payroll tax cut is viewed as a Democratic win, the Republicans should not object to whatever mechanism the Democrats choose to deliver the same amount of funds. Of course, it would be better for all if the White House would just do the right thing and stop insisting on a payroll rate reduction.
Cross-posted from New Deal 2.0.