Would you like to see the FICA item on your pay stub go away and be able to keep the 7.65 percent that the payroll tax takes out of your paycheck? If so, Republican presidential candidates Rand Paul and Ted Cruz have a deal for you – each of them has proposed getting rid of the tax. The senators’ plans would also eliminate the other 7.65 percent that the government collects from your employer, which you ultimately pay in the form of lower wages.
The payroll tax has some problems. It penalizes work and it’s burdensome, especially for low-wage workers, because it kicks in at the first dollar. Also, the half of the tax that’s collected from employers is hidden from workers, making it harder for taxpayers to see the true cost of their government.
Unfortunately, getting rid of the payroll tax would cause even bigger problems, unless it’s done as part of a well-thought-out entitlement reform.
The payroll tax finances two large benefit programs – 6.2 percent goes to Social Security and 1.45 percent goes to Medicare Part A. If the payroll tax went away, we would have to find another way to pay for those benefits. Paul and Cruz would turn to a value added tax, known as a VAT. Because their plans would also slash income taxes, the VAT would end up funding much of the government’s general operations, as well as Social Security.
Unfortunately, a VAT has many of the same problems as the payroll tax. And using it to pay for Social Security would have repercussions for the program that the candidates haven’t thought through.
A VAT would penalize work, just as the payroll tax does, because it would tax what workers buy with their wages. Like the payroll tax, a VAT would kick in at the first dollar. And, because the type of VAT that Paul and Cruz are proposing wouldn’t be listed on customer receipts or pay stubs, it would be even more hidden than the payroll tax.
More important, once the payroll tax was gone, Social Security would no longer be a self-financed program with its own funding source. Instead, it would draw on the same general revenues as other government programs.
From an economic standpoint, that’s not important – money is money and it doesn’t matter which tax money is tracked to which program. But having a separate funding source for Social Security has been good budgetary policy. It’s kept the program out of annual budget fights while controlling its long-run growth – Social Security spending is limited to what current and past payroll taxes can support.
Besides, scrapping the payroll tax would wreak havoc with the Social Security benefit formula.
Today, a worker’s Social Security benefits are based on the earnings on which he or she has paid payroll taxes (earnings exempt from the payroll tax don’t count). The formula is not proportional – if Smith earns twice as much wages, and pays twice as much payroll tax, as Jones, Smith gets a bigger monthly Social Security check than Jones, but less than twice as big. That’s a delicate compromise, giving more money back to those who paid more in, but offering low-wage workers, who need more help, a better rate of return on their tax payments.
So what would happen to the benefit formula if the payroll tax disappeared and Social Security was financed by general revenue from the VAT? Paul and Cruz haven’t said.
Keeping today’s formula probably wouldn’t work. Because high-wage workers would no longer visibly pay more into Social Security than low-wage workers, it would be politically difficult to continue giving them higher monthly benefits. Although high-wage workers would generally pay more VAT than low-wage workers, their payments would go to the general treasury, not specifically to Social Security.
One option would be to switch to a completely different formula, maybe a flat monthly benefit for all retirees. Three of my colleagues and I recently proposed moving to a flat benefit as part of a Social Security reform plan. But that would be a big step, cutting benefits for high-wage workers and posing tricky transition issues. If Paul and Cruz have something like that in mind, they haven’t spelled it out to the voters. We need to think through these issues before, not after, we scrap the payroll tax.
Nobody loves the payroll tax. But, there’s a reason it’s been used to finance Social Security. If we’re going to change how Social Security is financed, we should do it as part of comprehensive entitlement reform.
Until then, let’s stop using the payroll tax as a political football.
from AEI » Latest Content http://ift.tt/1OHiH1r
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