Don’t Pass the Payroll Tax Cut

FDR Signing the Original Social Security Act

Yesterday, the House of Representatives may have given the American people an early Christmas present – although the majority of my fellow citizens won’t realize it and (urged on by the President) will cry bloody murder. And yes, the motives of the House members are hardly pure. Those are certainly little more than angling for political gain. But the result is the same; an end to the insanity that is the payroll tax cut.

It isn’t that I’m opposed to tax cuts, in general principle. Anything that reduces the inflow of money from the private sector to the public is usually a good thing. But the consequences of reducing this particular tax levy amount to far more than the few pennies saved by the average taxpayer. Why? Because this is a targeted tax, whose revenue is designed purely to keep the Social Security system afloat.

Okay, some background here. The payroll tax amounts to 12.4% of the earned income of every wage earner in the country, up to $100,000. Of that, you normally pay 6.2% and your employer pays 6.2% (unless you’re self-employed, in which case you pay the full 12.4%). For 2011, Congress and the President reduced the amount paid by employees to 4.2%. That cost the Social Security system $117 billion. Now, here’s the rub: most people think there’s this massive social security trust fund, into which new revenues get deposited and from which existing current beneficiaries receive their monthly stipend. Reducing the amount coming for a year or two won’t matter, because the trust fund is earning interest on past deposits and there is plenty of time to make up the current shortfall. The reality is there isn’t a trust fund. There never was one; there never will be. Rather, the money you pay in is turned right around to retirees. Smart people realized that the system as it existed was untenable back in the 80’s; they worked out some changes in the ways benefits are paid and increased the payroll tax. Depending on who you talk to, the system was saved from insolvency until 2037 or 2052.

Except the $117 billion that came out of this year’s Social Security funding left us with an $83 billion shortfall, either 26 or 41 years before it was supposed to happen. If the payroll tax remains at 4.2% for this year, the CBO expects the shortfall to top $105 billion. (Actual reduction in revenue amounts to approximately $120 billion). The folks in the Senate came up with some neat trickery to “pay” for the reduced payroll tax, mostly relying on forecasting budget cuts 10 years down the road to pay the difference. That’s not exactly a reliable funding formula, but it is what passes for budget restraint these days.

What I find really amazing about the whole thing is the way Democrats – supposedly the guardians of the Social Security system from all assaults – have caved on this issue. Most of them probably haven’t realized yet that by breaking the essential funding formula created by the original Social Security Act and relying on general revenues to keep the system solvent, they’ve subjected their sacred cow to the whims of future Congresses. I can’t imagine they actually thought through the idea that Social Security is now on the general budgeting table, open to political negotiation on funding – and payments.

I think most people realize that Social Security needs to be revisited, if for no other reason that retirees are living longer and collecting more. Pro-rating payments, delaying the official retirement age, means testing, even incorporating private retirement accounts should all be on the table. But if Congress continues reducing the inflow of funds in to the Social Security system, the idea that we can address the topic later rather than sooner will be gone.