By Jordan Harris
Pegasus Institute
The U.S. economy is entering a period of uncertainty, as reflected by the unprecedented volatility of the stock market in recent days. It is unclear how long the global economy will be impacted by COVID-19, how much it will impact growth in the second quarter, and how many jobs will be lost. Estimates for potential decline during the second quarter have been as high as minus-5% with the potential for as many as 1 million job losses in April alone.
The Trump Administration has, virtually since the first signs of market volatility, promoted a payroll tax holiday as a way to offset the downturn and is reportedly preparing an $850 billion request for Congress with a payroll tax holiday as the centerpiece. This is not the first time the administration has floated the idea of a holiday, first doing so in August of 2019 before Trump quickly backtracked on the idea.
There was a time, during the previous administration that ideas like this were dismissed as Keynesian demand stimulus and largely panned by Republicans. It is unclear how much steam or opposition the proposals have today though.
Regardless of the merit of a discussion, at some point, about reducing the payroll tax, which makes up 35 percent of all federal receipts, there is no evidence that a holiday right now will offset the economic downturn or provide many benefits to the populations most impacted by the closings of schools and businesses in the wake of COVID-19.
As reported by Politico earlier in the month, there is skepticism of the proposal from both right and the left:
Still, that doesn’t even get into the question of whether a payroll tax cut would even be much help against a slowdown caused by a coronavirus outbreak. The aim of a payroll tax cut is to get more money into regular workers’ pockets, to give them more to spend . . .
“I don’t think something like a tax cut now is going to do much to address the issue. People are going to stay home and purchase less because they want less human-to-human contact,” said Kyle Pomerleau of the American Enterprise Institute.
“Giving them money is unlikely to do much. Same deal for a tax cut for businesses right now.” Another potential issue: “I worry that a payroll tax cut would not do anything for people who do not work — the unemployed or old — or people who lose their job as a result of the virus,” said Bill Gale of the Urban-Brookings Tax Policy Center.
Spreading out the impact when need is immediate
Payroll taxes come partially from the paychecks of workers. The federal government takes 12.4 percent towards Social Security and 2.9 percent toward Medicare. For many workers, half of this total is paid by the their employer and half is taken from their paychecks. Self-employed workers pay the full percentage themselves.
For a worker making $50,000 a year, a payroll tax holiday would mean approximately $1,000 back in their pocket, mirroring the potential stimulus proposals that have been floated by some economists and politicians. Unlike the stimulus proposals though, a payroll tax holiday would spread the money out over the course of the year, rather than providing the immediate impact that workers need.
That issue pales in comparison to perhaps the bigger problem of providing limited relief to income groups that have been impacted by the sudden economic changes and provide unnecessary capital to income groups that are more stable. Because the payroll tax is a flat percentage of wages, a tax holiday would have a disproportionate impact on higher-income earners and would be unlikely to provide much benefit for lower-income groups.
The proposal might help us recover from a downturn more quickly, assuming the quarantine period and downturn are short lived, but in the immediate, workers who have found their hours reduced by business closures, who are required to take time off for child care, or who have found themselves suddenly without work would see little to no benefit from a payroll tax holiday.
Impact on Social Security and federal budget
While the proposal would have a limited impact on the Americans who will be most in need of assistance, it will have major implications for social security and the federal budget.
Social Security is a self-sustaining program, for now, thanks in part to the dedicated revenue stream of payroll taxes. As noted by the American Enterprise Institute, a “payroll tax holiday would reduce the flow of earmarked taxes into the Social Security trust fund. To offset that loss, Congress would almost certainly transfer money from the general treasury into the trust fund, just as it did during the 2011-2012 payroll tax holiday.”
It’s worth noting, the holiday referenced from 2011-2012 was a reduction in rates, rather than a complete elimination, as is being proposed now (the employee payroll tax rate was lowered from 6.2 percent to 4.2 percent, and the self-employment tax rate from 12.4 percent to 10.4 percent) and was still highly costly to the federal budget. Congress transferred $103 billion to the Social Security trust fund in 2011 and another $114 billion in 2012 to offset the reduction in rates.
What impact could a reduction have now? Quoting from Alan Vaird’s October 2019 white paper on the subject:
The Penn Wharton Budget Model recently estimated that a one-year, 2-percentage- point reduction in the employee payroll tax rate in 2020 would increase real GDP by 0.3 percent in that year but would reduce GDP slightly in later years. The holiday would reduce revenue by $151 billion. The Committee for a Responsible Federal Budget similarly estimated a revenue loss of $70 billion to $75 billion per year per percentage point reduction in the employee payroll tax rate.
What should Congress do?
Congress should reject the proposal for a payroll tax holiday. The benefit will be very limited and carry a high cost for the Social Security trust fund, one that will either be paid with general fund revenues or shorten the solvency window for the program. Better proposals, which are already being floated, would more effectively target the affected populations without damaging Social Security both of which are possible, while acting to stabilize the economy and provide the nation with enough time to figure out the full extent of the crisis and what it will mean for our economy moving forward.
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