Would Obama’s payroll tax cut hurt Social Security?

The Congressional Super Committee hasn’t even started cutting Social Security, but advocates are already expressing concern on a different front: the payroll tax cut extension proposed last night by President Obama as part of his jobs plan. Those payroll taxes fund the Social Security program.

The President asked for a $175 billion one-year extension and expansion of the employee payroll tax holiday now in place, halving the tax rate to 3.1 percent in 2012. He also proposed halving employer payroll taxes to 3.1 percent for the first $5 million of payrolls in 2012. The president also wants a complete payroll tax holiday that would apply when companies grew their payrolls by up to $50 million in a year by hiring new workers or raising the salaries of existing workers.

These cuts in the Federal Insurance Contributions Act tax (FICA) may be one of the best available stimulus options in the current political climate, and they will have a positive economic impact. An analysis by The Center for Budget and Policy Priorities notes that the cuts already in place make a substantial difference in the spending power of middle class families, and that allowing them to expire at this time would be very negative for growth:

Failure by Congress to extend the temporary payroll tax cut enacted last December would reduce all paychecks starting on January 1, withdrawing needed support from the still-weak economy. The measure, part of the tax cut-unemployment insurance deal between President Obama and Republican leaders, reduces the employee share of the Social Security payroll tax,[1] boosting workers’ take-home pay by an estimated $120 billion in 2011. The tax cut is worth $934 to the average worker.

And Moody’s Analytics estimates that allowing the payroll tax cuts to expire would reduce GDP growth by one percentage point in 2012, translating into one million fewer jobs by the end of next year.

But Social Security advocates worry that these temporary payroll tax cuts will never be restored. “The problem is, it is very easy in our current political climate to cut revenue and very hard to increase it,” says Nancy Altman, co-director of the Strengthen Social Security coalition and author of The Battle for Social Security, an excellent history of the program and its politics.

“Look at the controversy over ending the Bush tax cuts, which would only affect a small portion of taxpayers,” Altman says. “In this case, if you propose restoring the payroll tax down the road, you’d have to double the rates on workers making minimum wage. This is being sold as temporary, but it’s not likely to work out that way.”

The current and proposed FICA tax cuts don’t directly affect the long-term health of Social Security, because the revenue that normally flows direct to the Social Security Trust Fund is being reimbursed out of general revenue. But that so-called “hold harmless” provision now gives Social Security a direct role in rising deficits for the first time. Up until now opponents have sought to tie the program to the deficit by arguing that the Social Security Trust Fund is just a collection of worthless IOUs, but those arguments don’t hold water.

The FICA tax may not be the ideal way to fund Social Security. As Altman notes, the tax is regressive in that it collects tax on the first dollar earned by workers, and is capped at $106,800 in income (See: Warren Buffett). But it’s an approach all sides have been able to live with from the program’s inception in the 1930s.

“In fact, it was the conservative approach at the time of Social Security’s inception,” Altman says. “Business and labor could both live with it. Now, we’re talking about changing the funding for a program that was worked well for 76 years without any thoughtful discussion of what that means. Is it a good idea? A bad idea? We’re in uncharted territory.”