Social Security payroll tax cut is no way to give workers a break

The 'temporary' tax cut skips over millions of Americans, including some of the poorest laborers. And it potentially undermines Social Security. Why not simply reduce withholding, as was done for Making Work Pay?

|Michael Hiltzik

There are reasons to like the tax-cut deal President Obama reached with Republican congressional leaders this month, and reasons to dislike it.

Here's the part to hate: The "temporary" one-year reduction in the Social Security payroll tax.

We can debate whether the wealthy need or deserve an extension of their income tax breaks President Bush gave them starting in 2001. We can debate whether people who inherit fortunes need a cut in the estate tax. Or whether the overall package will have as much stimulative effect as a tax cut aimed squarely at the middle class and working class.

But even assuming you want to deliver a break to the workers for whom the payroll tax is the biggest item in their federal tax, what's not debatable is that this is the wrong way to do it.

Why? Because it skips over millions of Americans, including some of the poorest laborers. And it potentially undermines Social Security.

"It's basically blowing a hole in the system," Nancy J. Altman, co-director of Social Security Works, a nonprofit advocacy group, told me.

On the positive side, it exposes all the talk we were hearing from the deficit commission only a month ago about the desperate need to fix Social Security now as so much deplorable balderdash. Some of us knew that anyway, but it never hurts to have another data point.

Here's the good news: While public support for the overall tax package is 69%, according to an ABC News/Washington Post poll released Monday, 57% of the respondents opposed the payroll tax cuts. The overall support cut across all political colorations, but so did the opposition to the payroll tax cut. It looks like the public may have gotten the message that tampering with Social Security, which serves millions of Americans flawlessly, is a dumb idea.

Let's examine the problems with the payroll tax plan, which involves a reduction in FICA withholding by 2 percentage points during a one-year "holiday."

First, the benefits are inefficiently targeted. The payroll tax cut is designed to substitute for the Making Work Pay tax credit Obama implemented last year as part of his stimulus package. That credit was calculated as 6.2% of your pay, up to a maximum of $400 for single persons and $800 for couples.

Families earning more than about $12,900 got the maximum. The benefits were reduced starting with taxpayers with $75,000 in taxable income ($150,000 for couples), and fell to zero for anyone earning $95,000 ($190,000 for couples).

The payroll tax break comes to a maximum of $2,136 per worker, which is 2% of wages up to the maximum of $106,800 per wage earner subject to the payroll tax. A well-paid two-earner couple could receive as much as $4,272. There's no phase-out — anyone who makes at least $106,800 gets the max.

Any couple earning less than $40,000 reaps less from the payroll tax cut than they did from Making Work Pay. (That's the level at which the 2% cut yields $800.) Above that threshold, the new scheme provides a bigger break.

Then there are about 5.7 million state and local workers who aren't enrolled in Social Security. They were eligible for Making Work Pay. Under the new system, they'll get nothing. On the plus side, your favorite CEOs each get a much-needed $2,136.

As for the long-term impact on Social Security, its chief actuary, Stephen C. Goss, has ruled that the system's financial status will be "unaffected" by the payroll tax cut. But that's based on the promise, explicit in the tax-cut deal, that every dollar of diverted money will be paid into Social Security from the government's general fund and credited to the workers getting the break in 2011.

Social Security advocates rightly find cold comfort in such assurances. They note how hard it is to restore a tax after it's cut — if Obama restores the full payroll tax a year from now, won't Republicans claim that he's raising taxes on middle-class workers? Yet a permanent reduction will turn Social Security into a ward of the Treasury forever, giving its enemies the opportunity to chip away at it year after year.

Why does a tax-rebate stimulus have to be delivered through the payroll tax at all? Why not simply reduce withholding, as was done for Making Work Pay?

Social Security advocates are a paranoid bunch — that comes from years of explaining over and over again to ideology-addled politicians, soft-minded journalists and perplexed taxpayers that almost everything they've heard about the program's problems is mistaken or fabricated — but they're correct that this only muddies the system's accounting.

One fascinating aspect of the proposed tax cut is that it diverges from the anti-deficit theme of the last month. Listening to Alan Simpson and Erskine Bowles, the co-chairmen of the deficit commission, you'd think the entire country would be plunged into the dark ages unless we stopped borrowing, right now. The incoming GOP majority in the House was all about this brand of fiscal responsibility. Then, first shot out of the box, they sign on to a payroll tax cut to be financed by $120 billion or so in borrowing.

Social Security's drafters thought that the system's long-term survival depended on making it contributory through the payroll tax. Without worker contributions, they told Congress in 1935, old-age pensions would cost the U.S. Treasury $1.8 billion by 1980, a sum they thought the country might consider unsupportable. (The program, and the economy, were much smaller then.) Instituting contributions promptly would cut the bill to $500 million, mostly to support retirees not otherwise covered by the system.

Franklin Roosevelt claimed that he made individual contributions a part of the system to give enrollees a sense of ownership, so "no damn politician can ever scrap my social security program." (This may have been an afterthought, as the remark dates from 1941, long after the program was established.)

The payroll tax does have the flaws identified by critics. It's regressive, and the wealthy are permitted to dodge their fair share of its overall costs; one of the sensible proposals made by Bowles and Simpson was to raise the ceiling on earnings subject to the tax, though they didn't raise it high enough.

But its flaws are outweighed by its virtues. Through the recent fiscal debate, having its own dedicated revenue stream is what enabled Social Security to make the case accurately that it doesn't contribute anything to the federal deficit.

If you're going to toy with this essential part of the machine, you better have a good reason. So far, there hasn't been one.

Michael Hiltzik's column appears Sundays and Wednesdays. Reach him at mhiltzik@latimes.com, read past columns at latimes.com/hiltzik, check out facebook.com/hiltzik and follow @latimeshiltzik on Twitter.

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