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How Not to Make Public Policy: The Payroll Tax Cut

Charles Blahous | 02/15/2012
Hemera

It is rare that an act of legislation encompasses nearly every feature of poor public policy making in the manner of the current “temporary” Social Security payroll tax cut.  Imperfect legislation is of course the norm in any system that brokers compromises between competing interests, but more typically even the worst outcomes advance the general policy objectives of one side even as they may be fiercely condemned by the other.  The payroll tax cut, by contrast, serves almost no productive purpose while causing severe adverse consequences from almost any conceivable policy vantage point.

The following is but a partial list of the problems associated with the policy.

1. Instability, uncertainty and brinksmanship. In December, 2010, prodded by the Obama Administration, Congress consented to “temporarily” reduce the Social Security payroll tax for (as then described) 2011 alone. The pending expiration of that policy created uncertainty for affected parties ranging from taxpayers to Social Security advocates. It was more recently extended for another two months, barely allowing for a hiatus in the disruptive atmosphere. It is now anyone’s guess how long it will continue to be extended. Outside parties are meanwhile receiving conflicting signals, being told on the one hand that the policy is temporary – not a permanent reduction in Social Security tax revenue – while they simultaneously hear elected officials announcing that it will not soon expire. Taxpayers are given constantly shifting information about what their tax burdens will be, while investors do not know the ultimate effect on the federal debt. This environment is the exact opposite of the kind that allows private sector actors to make responsible decisions that foster economic growth.

2. Undermining Social Security finances. In its first year alone, the payroll tax cut reduced Social Security tax income by $105 billion. During a second year it would cut Social Security’s tax income by even more. For decades it has been known that Social Security faces a long-term shortfall and that its costs would rise markedly when the first baby boomers started claiming benefits in 2008. As bad fortune would have it, that event coincided with the Great Recession, depressing the program’s revenue intake and causing its expenditures by 2010 to exceed its tax income for the first time in decades, far earlier than prior projections. Historians will someday scratch their heads in amazement over lawmakers’ response to Social Security’s weakening; taking action to dramatically and dangerously reduce the program’s tax collections below their already-depressed levels.

3. Worsening budget problems. It now appears that the extended tax cut will simply be added to the deficit with no budgetary offsets. It is well known that the federal government is running its fourth consecutive year of unsustainably large deficits, with no end in sight. It has proved nearly impossible to find a mutually acceptable way to keep the payroll tax cut from increasing the deficit, with one side wanting to cut spending and the other wanting to raise taxes. These conflicting proposals overlay a similar divide over how to bridge gaps in the underlying federal budget. Our general budget policy paralysis was already problematic enough before creating the additional recurring issue of whether and how to also budget for the payroll tax cut.

4. Undermining budget transparency. Lawmakers used a budget gimmick to transfer $105 billion to the Social Security Trust Fund in last year alone – and likely still more this year -- to make it appear that it is unaffected by the reduction in its tax income. Lawmakers don’t want to be seen as weakening Social Security, which reducing its payroll tax income obviously does. So tucked away in the payroll tax cut legislation was a provision transferring general revenues into the Social Security Trust Fund in amounts sufficient to replace the lost revenue. This revenue infusion – in the form of legally-binding Treasury debt obligations -- in effect means that income taxpayers are being committed to subsidize Social Security without being forthrightly informed of it. The misleading impression given is that the public can keep some of their payroll taxes and yet the same money will still arrive in the Social Security Trust Fund, a double-count only made possible by the quiet commitment of over $200 billion dollars in income taxes.

5. Destruction of the historical Social Security compact. For decades, Social Security’s bipartisan political support rested on the proposition that it was not welfare, but that program beneficiaries had, at least in the aggregate, paid for their benefits. This enduring foundation of Social Security has been jettisoned in the name of short-term stimulus. FDR envisioned a Social Security program whose benefits would be politically inviolate because they were financed by separate worker contributions in a separate Trust Fund. This longstanding special status was ended by the hasty decision just over a year ago to begin subsidizing Social Security with income taxes to cover for a policy of cutting payroll taxes.

6. Undercutting the quality of the public policy debate. The sole justification for all of this public policy damage is that extending the payroll tax cut is necessary to maintain progress in economic recovery. This argument, already questionable with respect to the first one-year cut, was made risible by the recent action to extend it by two months (as though lasting private-sector employment and investment will be committed to on the basis of tax relief parceled out sixty days at a time). There are, however, economic models that can be programmed to essentially assume that result. This induces sympathetic experts to speak on behalf of this policy even though it is being implemented in a way that is manifestly ineffective to its stimulus purpose, thereby invalidating the models used to advocate for it. All of this undercuts public confidence in the rationality of the decision-making process.

7. Temptation to use irresponsible budget offsets. The public commitment of lawmakers to extend the payroll tax cut through year’s end engendered some desperation in the search for budget offsets. Recently shopped on Capitol Hill was a proposal to “raise revenue” by allowing employers who sponsor pension plans to reduce their required (tax deductible) pension contributions. If that had been used to “pay for” the payroll tax cut it would have meant, incredibly, that lawmakers had employed a policy of deliberately further underfunding employer-provided pensions as a means of budgeting for a policy of deliberately further underfunding Social Security.

The political dynamic surrounding the payroll tax cut has now evolved in such a way that neither party wants to be blamed for its expiration, so it will likely be extended even though it has now become almost a perfect storm of policy mistakes. Its ultra-temporary nature undoes virtually all of the positive stimulus impact claimed for it, while the adverse effects include high policy uncertainty, undercutting budget transparency, increased fiscal pressure, and lasting damage to Social Security’s financial and political foundation, this last of which may well prove irreparable.

Our public policy process is ever an imperfect one, necessarily producing messy outcomes because of the compromises necessary between conflicting perspectives. But even by these standards, it is rare for policy makers to inflict as much damage as is being done with the payroll tax cut. If lawmakers cannot muster the will to terminate it now, one must hope that they are able to do so before it goes on too much longer.

Charles Blahous is a research fellow with the Hoover Institution, a senior research fellow with the Mercatus Center, and the author of Social Security: The Unfinished Work.

This piece was accidentally listed as an e21 staff editorial when it was first posted. It is, in fact, written by Charles Blahous.


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