Cutting payroll taxes to quickly put money into the pockets of low- to middle-income workers — an option being considered for Congress’ economic recovery package — could weaken the already-stressed Social Security safety net financed by the weekly taxes on salaries.
Social Security’s defenders say a payroll tax cut would drain needed funds from the already weak retirement system — a squeeze that is made worse by the economic recession and millions of baby boomers who will soon be retiring.
Details of the stimulus package are still being worked out between President-elect Barack Obama and congressional leaders, but Capitol Hill aides familiar with the negotiations say lawmakers from both parties have put a temporary reduction in the payroll tax on the table. Another method under discussion is to lower withholding levels for income taxes.
“The payroll tax is an easy method to distribute tax cuts and it’s well targeted at low-income people,” said Maya MacGuiness, president of the Committee for a Responsible Budget. “But on the other side, the payroll tax is a dedicated tax, with most of it going to Social Security, and any tax cut diminishes the money that goes into that system, leaving it weaker than it already is.”
On Thursday, a day after Mr. Obama vowed to tackle the long-term viability of Social Security and Medicare, an Obama transition official shot down the idea that a payroll tax cut will be used to give about $500 to individuals and $1,000 to families with incomes of less than $200,000 a year.
“It is an income tax cut,” the official said.
The transition, however, has said it wants the rebate on weekly paychecks and to include workers who do not make enough money to pay year-end federal income taxes, which would point to the payroll.
The president-elect wants to avoid handing out the tax cut in a lump-sum payment that people likely would save or use to pay down debt rather than pump into the economy. This happened to much of the $152 billion stimulus rebate paid out early last year, so Mr. Obama instead wants to distribute rebates in the form of reduced payroll taxes to make successive paychecks fatter.
At least 53 House Republicans already are calling for a two-month holiday from the personal income tax and FICA (Social Security) tax at an estimated cost of $350 billion, a concept supported by supply-side Republicans.
“Cutting the payroll tax is a great idea. It not only puts money back in people’s pockets — particularly for working- and middle-class Americans — but it reduces labor costs for employers because they pay half of the tax,” said economic strategist Cesar Conda, who was Vice President Dick Cheney’s chief domestic policy adviser.
“I think most supply-siders would be supportive. It’s clearly the best pro-growth tax cut that we could ever hope from an Obama administration,” Mr. Conda said.
Several economic analysts with close ties to some of Mr. Obama’s advisers and top officials at AARP said their understanding of the range of options being considered would not endanger Social Security’s finances.
One AARP official said that a reduction in the amount withheld from worker paychecks could be designed as a credit that would not reduce the payroll taxes that are credited to the system’s trust funds or the amount that would be credited to each worker’s future retirement checks.
“Depending on where you are on the income scale, it may be the only tax you are paying if you are below the income tax threshhold,” said David Certner, legislative policy director for the AARP.
“As a stimulus, those people on the lower end of the income scale tend to spend most or all of their income, so any additional money in their paychecks is much more likely to go into spending. So that makes more sense in terms of economic stimulus,” Mr. Certner said. “We don’t want to reduce revenue to the trust fund, but we want to see that people who are working get proper credit for their contributions to Social Security.”
If Mr. Obama proposes cutting the payroll tax, some Democrats said, any drop in the system’s income would be small compared with national economic troubles.
“It all concerns me, but we have a house on fire now. We have to put the fire out and deal with the water damages later. That’s not a top concern right now,” said William G. Gale, director of economic studies at the Brookings Institution.
“The money not going into the Social Security system would be relatively small potatoes when compared to the situation we’re facing right now. If the economy tanks, Social Security will be in much worse shape than if the economy is strong,” he said.
Mr. Gale predicts that in the end the tax cuts “will be in the income tax. That’s how I always understood it. I’d be surprised if it were different but I don’t know for sure.”