The middle class is shrinking. Those in power have run up enormous debts on public credit while shoveling most of the money into private pockets. The corporations that have benefitted from this borrowing binge, meanwhile, leverage the global trade system to transfer their profits beyond the reach of national governments.

Meanwhile, we have been told lies by Democrats and by Republicans, divided into artificial camps and led into debates that are either irrelevant or so dramatically scripted that we fail to realize every choice leads to the same result: the dismantling of the social framework that defined and sustained the opportunity of the last century. National mobilization of resources has given way to radical individualism under a narrative that, in the wealthiest nation in the world, we must always expect less.

In this tumultuous time, we search for a way forward - a new Square Deal for the American people.

Tuesday, December 6, 2011

The Payroll Tax War

Democrats and Republicans are up in arms over the proposed extension and deepening of a cut to payroll taxes, the line item wage-earners see on their paychecks under the label FICA.

Let's look at what FICA is, why there's an argument, and what makes sense.

FICA 101

The Federal Insurance Contributions Act is the mechanism that collects money to fund Social Security and Medicare (though on some pay stubs, Medicare gets its own line item).  First established in 1939 after being moved from a 1935 provision co-enacted with the original Social Security Act, FICA has grown over the decades but retains two noteworthy traits:
  1. It is levied on each employee (because employment is what qualifies someone for Social Security), with portions paid by both the employee and the employer; and
  2. The Social Security portion (which from here on is what we'll call FICA, leaving out the 3.3% combined Medicare tax) is levied against earned income only up to a particular cap.
As of 2011, the "natural" FICA tax is 12.4%, with 6.2% paid by the employee and another 6.2% paid by the employer.  (The employee portion is what you see withheld.)

Is FICA regressive?

Because FICA starts at $0 and continues up to the cap, some people say that the tax is regressive -- that is, it affects people whose total earned incomes are equal to or below the cap more than it does those whose incomes are higher than the cap.  This argument would seem to be valid: the former pay FICA on all of their earnings while the latter see FICA withheld only until their gross pay for the year reaches the cap, after which FICA is no longer withheld from their paychecks. 

On the other hand, all of the money that someone pays into FICA is eventually returned (given sufficiently advanced age; it is impossible to outlive Social Security, which is itself old-age insurance and not a pension), and indeed those with the lowest incomes garner more from the program relative to their contributions than those with higher earnings.  For that reason, others -- including the Congressional Budget Office -- consider FICA to be a progressive tax, offering higher earners a less attractive deal.

People who make more than the cap therefore reach a point each year where their net pay goes up, and it stays up until year's end.  The 2011 contribution cap is $106,800, and it generally rises from year to year.

The 2010 Experiment

In 2010, Congress enacted legislation that cut the employee portion of the FICA tax from 6.2% to 4.2%.  Because everyone with earned income pays FICA, just about every American saw a net increase is his or her paychecks for 2010.  Anyone earning $20,000 per year took home an extra $15.38 per biweekly check. Those with incomes at or above the FICA cap of $106,800 saw an extra $85.13.

Like the $300 rebates sent out by the IRS in 2003 as part of the second round of Bush tax cuts, the FICA tax cut was meant to give us all an incentive to spend more.  Dollars spent = demand created, which in turn leads to more staff needed, and jobs are made; that's the thinking, anyway.

It's not clear whether it actually worked.  There are reports that the reduction in FICA may well have created or supported almost half a million jobs.  Others dispute that number, and when one looks at the dollar values, there's some reason to be skeptical.  An extra $30.76 among low-earners?  It's hardly a windfall, and with the job picture being what it is, it seems just as rational to dedicate that repeatable extra cash to debt reduction as to use it for splurges.

The Argument

Democrats want to extend the payroll tax cut.  Actually, they want to deepen the cut, reducing the employee rate to just 3.1% for 2012 -- half of what it would normally be.  And even that is a scaled-back version.  President Obama wanted to reduce the employer-side rate to the same 3.1%, arguing that it would make it easier for companies to create jobs.  (That idea has since been jettisoned.)

Democrats want to pay for the payroll tax cut with a surtax on high-earners.  Now that Congress has postured to the cameras that nothing is more important than deficit reduction, everything has to be paid for in some way.  Since FICA goes to pay for Social Security (and especially since its surplus goes to cover some of the deficit spending that we're already doing), cutting 3.1% off of the total 12.4% FICA tally is a big-bucks idea.  Democrats have proposed making up the revenue with a surtax imposed on people making more than $1 million per year.

Republicans denounce the surtax as a "job killer."  It would be significantly more believable if Republicans hadn't spent 2011 denouncing everything as a "job killer," but the argument is that many small businesses are subject to pass-through taxation, and that many of those supposed millionaires are in fact small businesses.  (A proposal by Senator Susan Collins, R-ME, would exempt anyone who met the threshold because of Schedule C small-business income.)

Republicans do not want to extend the payroll tax cut at all.  President Obama has spent considerable time and effort as of late pointing out that Republicans consider it a moral imperative to never raise taxes under any circumstances, yet have found cause to waver in that conviction the one time that the tax in question is of significance first and foremost to lower-income people.  Some of the strongest opponents agree: fervent supply-side advocates, these critics assert that the money handed to lower-income people does not have positive economic value.

Republicans are trying to make a deal.  Facing the expiration of these tax cuts next year, many of the same people who have said that the payroll tax cut is bad policy have indicated a willingness to extend it anyway if they get what they they want: the making permanent of the 2001 and 2003 Bush tax cuts, which are set to expire next year.

Policy Implications

The effectiveness of the payroll tax cut is a matter of political debate, but there is little debate among economists: money handed to people who spend it does indeed have a stimulative effect.  How stimulative is not as easy to pin down -- did the cut create 400,000 jobs or just 180,000? -- but the effects are real.

Progressives should be concerned, however, to hear people like Nancy Pelosi touting the idea that cutting FICA leads to job growth in America, or hearing Barack Obama say that people have gotten used to the lower rates and will be outraged to see their taxes go up next year.

Remember, FICA is not just another tax.  It pays for Social Security. 

Now, it's true that year after year, the U.S. government has since the 1980s stolen... err, borrowed... all of the surplus revenues that were meant to be stockpiled in the Trust Fund, and spent these to cover just part of the budget deficit that has grown steadily for decades.  It's therefore true that Social Security does not actually have the money it needs to pay its bills, and that to provide it means redeeming the bonds in the Trust Fund out of current revenues.

But that is a matter of accounting.  The current revenues are indeed owed to the Trust Fund under the terms of its "investment," and if the spendthrift Congress is now scrambling to make good on those bonds, that doesn't change that the money was collected.  Social Security has until now paid its own way.

Cutting FICA changes that.  When we slice a fifth or a quarter of the income off of FICA, we're creating a literal shortfall -- not just an accounting matter caused by Congress, but a situation where less is coming in than is needed.  Social Security ceases to be self-funding and becomes parasitic.

Making the cut from 6.2% to 4.2% for 2011 was bad enough.  Making it deeper for 2012 will be far worse.  But the real problem is the language that the Democrats are using: if our economy needs a FICA cut in order to grow, if the American people are now "used to" the reduced rate and would be outraged to see an increase in 2012, then how will we ever get the rate back to what it is supposed to be?


President Obama seems to have found a winning issue hammering Republicans over their sudden willingness to stomach a tax increase under the sole instance where it would primarily affect low-earners.  He wants to keep hammering that point; fine.

Maddest of all would be for Democrats to make the deal that Republicans want, and trade a one-year payroll tax extension ($175 billion) for making permanent the Bush-era tax cuts ($1 trillion).  Those tax rates must be allowed to expire, no matter what, or our fiscal outlook is very bleak indeed.

As for FICA, to preserve Social Security, we should all hope that the payroll tax cut expires this year.  But if we do push through an extension, let's not repeat the Republican mistake of 2003.  Let's make sure that this time, a tax cut really is temporary, targeted stimulus, and that is goes on to die a natural death when the economy recovers.

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