In December, Congress voted to extend the so-called “payroll tax holiday” through the end of February, with a vote on a one-year extension scheduled before then. Most members of Congress, both Democrats and Republicans, now say they support the idea, but are arguing over how to pay for it. Supporters say it will put more money in people’s pockets, thereby stimulating the economy.
A reduction in the payroll tax by about one-third, for all workers, with an increase in take-home pay of between $1,500 and $2,000 per year? What could be wrong with that?
Plenty. Tinkering with Social Security’s funding puts the program at risk, while any benefit to the economy will be small.
As established by law in 1935, Social Security is funded by a payroll tax that is divided between the worker and his/her employer. Revenue from the tax is placed in the Social Security Trust Fund.
The contribution rate for employees was 6.2% until 2011, when it was temporarily reduced to 4.2%. (The employer contribution rate of 6.2% remained un changed.) The tax is applied only to the first $110,100 of annual income; on pay stubs, it is listed as a deduction for FICA, the Federal Insurance Contributions Act.
If Congress votes to extend the current “tax holiday” for another year, it means that the payroll tax will keep putting less money into the Social Security Trust Fund. Supporters of extending the tax holiday say no one should worry: they insist that the shortfall will be made up by transferring money from the government’s General Fund, so that there is no net reduction in Social Security funds.
But Congress is currently debating how to pay for those transfers from the General Fund, and that debate shows why a payroll tax reduction is dangerous for Social Security.
What mix of spending cuts or other taxes should cover the money that Social Security is losing through this payroll tax reduction? Democrats and Republicans differ, but both sides have agreed that spending cuts must be part of the answer. For example, Republicans want to cut the maximum for unemployment insurance from 99 weeks to 59 weeks, while Democrats say it should only be cut to 79 weeks.
In other words, Social Security funding is now being put in competition with other public programs for the same pool of funding. It has become entangled with the regular horse-trading of the congressional budget process.
And when this “temporary” payroll tax reduction again expires, Republicans and many Democrats will be reluctant to allow the rates to go back up as promised: there is a risk that the “temporary” reduction will be made permanent. This would certainly increase the pressure to reduce Social Security benefits, raise the retirement age, or make other cuts to the program.
Fundamentally, throwing Social Security into the regular budget process violates the program’s historic role as a social compact between the generations, with current workers paying the benefits of current retirees. The fact that Social Security is funded through payroll taxes, separate and apart from all other revenues raised by the government, has been key to its success.
Franklin D. Roosevelt understood this when he said in 1941, the payroll tax “give[s] the contributors a legal, moral, and political right to collect their pensions....With those taxes in there, no damn politician can ever scrap my Social Security program.” If Social Security funding becomes dependent on congressional appropriations, the program is undermined.
Social Security is designed to be a self-sustaining program. It does not use general tax revenues to pay benefits. The Social Security Trust Fund had a $2.6 trillion surplus in 2010 and can pay all currently promised benefits until 2038.
Contrary to many pundits and politicians, Social Security faces no immediate financial problems. Common-sense measures like these can ensure its financial stability past 2038:
*Lifting the cap on FICA wages above $110,100;
*Dedicating the estate tax to Social Security;
*Increasing the FICA tax rate by a total of 1%, with lower-income earners being compensated by the Making Work Pay Tax Credit.
As for stimulating the economy, there is wide agreement among economists that tax cuts are less effective than direct federal spending to create or preserve jobs. Congress should be debating a full employment program – not risky changes to the funding of Social Security.
Update: On February 17, Congress voted to extend the payroll tax cut through the end of the year. "I never thought I would live to see the day when a Democratic president...would agree to put Social Security in this kind of jeopardy," said Iowa Sen. Tom Harkin during Congressional discussions. "Never did I imagine a Democratic president beginning the unraveling of Social Security." For a review of media coverage, see Trudy Lieberman's article for cjr.org.
This article is the result of in the PSC Social Safety Net Working Group discussions. For more, contact John Hyland.