Cut Payroll Taxes and End the Social Security Myth

December 19, 2011 • Commentary
This article appeared in Forbes on December 19, 2011.

The debate over extending this year’s Social Security payroll tax cut has flipped Washington upside down. Democrats want to reduce taxes to get the economy moving. Republicans emphasize paying for essential government services. “Keep your word to the American people and don’t raise taxes on them,” opined President Barack Obama.

Like much else in Washington, D.C., the issue is being advanced for political advantage, not sensible governance. But policy good may yet come out of political evil.

In general, Democrat legislators want all Americans to pay more in taxes to fund the endless subsidies, giveaways, bailouts, and other wasteful rip‐​offs which fill the federal budget. Congressional Republicans typically oppose higher taxes while supporting most of the same programs. Instead of making tough decisions today, GOP lawmakers prefer to let future generations pay tomorrow.

At issue is a temporary cut in the payroll tax, nominally used to fund Social Security. Last year in the name of “stimulating” the economy — and as part of a larger compromise including extension of the Bush administration’s tax cut program — Congress voted to reduce the payroll rate by two percentage points. With unemployment still high and the reduction set to expire on December 31, President Obama urged renewal for next year. Since then the Democratic‐​controlled Senate and Republican‐​controlled House have sparred over the issue.

On Saturday the former voted to extend the cut for two months, as part of legislation similarly continuing unemployment compensation and pushing the president to approve an oil pipeline from Canada. However, the House has yet to vote and the Republican majority remains badly divided.

The federal government spends far too much money. But neither party has much desire to cut back. Democrats always have been Big Spenders. President George W. Bush and six years of the Republican Congress provided a dramatic lesson in fiscal irresponsibility, pushing outlays up across‐​the‐​board. President Obama and the Democratic Congress responded by spending even more wildly.

Where the parties differed was revenues. Democrats preferred to tax while Republicans favored borrowing. Unfortunately, holding down taxes did not do much to “starve the beast” as some advocates of limited government hoped. Still, fully funding current spending levels probably would encourage another round of spending increases.

Thus, we face a desperately irresponsible fiscal impasse, with $4 trillion in deficits over the last three years. Why payroll tax cuts now? The recovery remains fragile and failing to renew the reduction would mean a tax increase directly on job creation.

The GOP long has rebuffed calls on higher income tax rates for good reason. Behavior is affected by incentives for marginal behavior. That is, people decide whether to work or invest more based on the tax rate on the next dollar earned, not on the average on their overall salary. Set marginal rates high and people will work less to earn more dollars and consume rather than invest more of the dollars they do earn.

Unfortunately, the issue lends itself to class war demagoguery. Those who believe that people’s earnings effectively belong to the government talk about the “cost” of giving tax cuts, even though tax cuts actually reduce the amount of our money, earned by us, taken by government. Congress letting people keep their wages is much different than taking the money and giving it to someone else.

Moreover, any fair tax cut will leave more money with those who pay more in taxes. Today the rich pay the most: the top one percent of earners alone pays 39 percent of income taxes. Any across‐​the‐​board tax cut means that they will receive more money back — because they paid more initially. Yet Democrats denounce “tax cuts for the rich.”

After spending years fomenting class war, Democratic politicos could not urge further income tax rate reductions, especially since workers with the lowest wages have been dropped from the income tax rolls. But there remains the Social Security payroll tax, a separate proportional levy on incomes capped at $106,800. Reducing the rate by two percent delivers relatively more money to people with more modest incomes, though since there are more workers in higher income households the wealthier still do better.

There was nothing wrong with the Democrats’ idea in principle. The payroll tax directly raises the cost of job creation. But a temporary reduction does little to promote permanent employment growth. Few companies want to add new jobs, only to drop them in a year. Moreover, cutting taxes without cutting spending is a prescription for future fiscal crisis and higher taxes. Businesses thrive when they can rely on positive, permanent policy changes that encourage positive, stable economic conditions.

Moreover, Social Security is routinely, though falsely, presented as social insurance. That is, the program is supposed to be self‐​financing, with people paying into a fund which in turn pays their benefits. Social Security, in reality a public Ponzi scheme, maintains this illusion with individual contribution histories and a program trust fund. Alas, both are frauds — benefits only very roughly reflect taxes paid and the fund is an accounting fiction filled with worthless non‐​recourse bonds from the Treasury Department rather than with money.

Nevertheless, Democrats normally defend the program by embracing the social insurance myth. Proposals to either means test benefits, thereby cutting payments to the “rich,” or to allow young people to opt out and put their money into private retirement funds, generate horrified opposition. Yet the same people now propose to cut the revenues supposedly necessary to fund Social Security.

Some Republicans correspondingly have opposed extending the payroll rate cut. The program went into the red in 2010 and faces an unfunded liability of more than $17 trillion. If Social Security is real social insurance, then the two percent cut is utterly irresponsible and threatens the bedrock foundation of the American welfare state. In fact, Senators Tom Harkin and Bernie Sanders — Democrat and independent (socialist), respectively — oppose the rate cut for this reason.

If the reduction continues, people may start looking at the program differently. Social Security trustee Chuck Blahous observed that Congress was severing “the link between contributions and benefits.” Three score Democratic Congressmen wrote President Obama in July worrying that the cut “may be used as the first step in a larger battle to fundamentally dismantle Social Security.” AARP is worried: Vice President Nancy LeaMond insisted that the tax money be quickly repaid to “avoid undermining Social Security’s long‐​term funding stream.”

However, today Congress is focused on politics: Who does the middle class believe better represents the middle class? The Democrats finally found a tax cut issue that puts the Republicans on the defensive. Traditional roles, philosophies, and concerns have been tossed out the window.

Nevertheless, cutting the payroll tax can promote smaller, less expensive government. First, the reduction should be made permanent to maximize the economic impact. Potential employers need to be able to make long‐​term decisions. The best way for government to “create” jobs is to permanently cut the cost of private employers generating jobs.

Second, Congress should make up lost revenues by reducing outlays. The Senate‐​passed measure raises fees on federal housing subsidies through Fannie Mae, Freddie Mac, and the Federal Housing Administration — which is a step in the right direction. Other, more serious spending reductions should be added.

Third, Americans should debate about the future of the largest domestic program, which will do so much to contribute to fiscal catastrophe in the future. Why should rich people collect Social Security checks? Why should young people be forced into a system which will pay them less than they “contribute”?

Even the Democrats now are implicitly admitting that Social Security is just another federal welfare program. If so, why stop with President Obama’s two percent rate cut? President George W. Bush proposed allowing workers to place two percent of their taxes in private accounts. Congress should revive that idea.

So far the debate over cutting the payroll tax rate has generated far more heat than light. Even though the reduction is politics at its most pure, it undercuts federal myth‐​making about Social Security. That may help trigger a desperately needed debate over the future of the American welfare state.

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