Update: President Trump is considering temporarily eliminating the Payroll Tax. A tax of 7.2% on employees, and 7.2% on employers that affects every single person with or without a job.
President Trump on Tuesday floated the idea of temporarily doing away with the payroll tax in order to give the U.S. economy a boost as it struggles amid fears over the coronavirus outbreak.
Trump proposed reducing the payroll tax for both employers and employees from 14.4 percent to zero during a lunch with Republican senators where the economic response to the coronavirus was the main subject of conversation.
Additionally, sources told Fox News that Trump would like to eventually make the payroll tax cut permanent and fund Social Security, Medicare and unemployment insurance from general revenues.
The president first mentioned the idea of temporally halting the payroll tax on Monday during a news conference alongside the White House’s coronavirus task force. He also mentioned moves to aid small businesses and help hourly workers who might become sick.
“They’ll be very dramatic,” Trump said of the proposed economic measures during an evening briefing at the White House. “This blindsided the world and I think we handled it very well.”
Income tax cuts are great, but it's not the best way to help lower- and middle-class workers.
Why Payroll Taxes?
The payroll tax is a much heavier burden on the middle class than income taxes. According to the Tax Policy Center, 62 percent of all taxpaying households paid more in payroll taxes than income taxes in 2017; and 67 percent of households with incomes below $100,000 in annual income paid more in payroll taxes. The average effective payroll tax rate for households in the middle quintile of the income distribution was 8 percent in 2016, well above the average effective rate of 3.5 percent for income taxes.
In the past, policymakers have been wary of cutting payroll taxes because the revenue is used to pay for Social Security and Medicare Hospital Insurance (HI) benefits, and both programs are projected to run short of funds in the future. The current tax rate for Social Security is 12.4 percent of wages, split evenly between workers and their employers, up to a maximum of $127,200 in 2017. Social Security has an unfunded liability of $12.5 trillion over the next 75 years.
Workers and employers also pay a combined 2.9 percent tax for Medicare, and there is no limit on the amount of wages subject to the tax. High earners — individuals who earn above $200,000 and couples who earn above $250,000 — pay an additional Medicare tax of 0.9 percent. The Medicare HI trust fund has an unfunded liability of $3.3 trillion over the next 75 years.
In 2011 and 2012, President Obama supported and Congress enacted a 2 percentage point reduction in the employee portion of the Social Security payroll tax, reducing revenue by about $100 billion in 2011 and slightly more in 2012. The law transferred an identical amount of funds from the general fund of the Treasury to Social Security to prevent depletion of the program’s trust funds.
Congress could enact another payroll tax rate cut of 1.5 to 2 percentage points without depleting the Social Security or Medicare trust funds and without relying on another transfer of funds from the Treasury. Tax reform is supposed to be about cutting tax rates as well as broadening the tax base by closing loopholes and limiting tax breaks. There are a number of tax breaks that reduce the amount of payroll tax revenue collected by the government that could be narrowed to help pay for a cut in the payroll tax rate.
How to Do It
For starters, the exclusion of employer-paid health-insurance premiums from taxation will reduce payroll taxes by $1.8 trillion over the period 2017 to 2026. Capping the amount that is tax-free at the 75th percentile of plan premiums would increase payroll tax revenue by about $72 billion over 10 years. In addition, employer-paid premiums for disability and other income-replacement programs are excluded from the taxable compensation of workers. Limiting that exclusion could provide at least another $100 billion in payroll tax revenue over 10 years. In a large tax reform package, there are likely to be additional opportunities to increase payroll tax collections by broadening the tax base.
Further, the full benefits of a payroll tax cut could be limited to households with incomes below a certain threshold, such as $75,000 per year. (The income tax system could gradually recapture lost payroll tax revenue from households with higher incomes.) The tax cut could also be time-limited in the initial legislation, so as to fit within available offsetting revenue increases, and then extended later as more offsets were identified.
A cut in the payroll tax rate would be good for workers. A 2 percentage point reduction in the total tax would increase the after-tax income of a household with $50,000 in earned income by $1,000. Cutting payroll taxes would also boost economic growth by encouraging more work. A cut in the tax rate could, at least in theory, reduce the supply of labor by boosting the income of workers who could then substitute more time off for time at work. But there is substantial evidence that high marginal tax rates on labor generally have the opposite effect: discouraging work by reducing its value to workers with high taxes.
Some skeptics of cutting payroll taxes argue that because Social Security and Medicare benefits are partly based on what an individual earns while working, the economic value of such a cut is lessened, as workers equate payroll taxes with contributions toward their retirement. But the benefits owed to workers under Social Security are based on the amount of wages earned by the worker, not the taxes paid on those wages. Consequently, a cut in the payroll tax rate would in no way lessen future Social Security benefits. Further, the opaqueness and complexity of the Social Security benefit formula make it near impossible for the average worker to make a sensible connection between what he earns and what he will get in retirement. (There is often very little connection, anyway.) Medicare benefits are in no way tied to the amount of taxes paid or even to overall earnings. Instead, workers must meet a minimum threshold of wages over a 10-year period to become eligible for coverage at age 65.
By focusing tax reform on the individual and corporate income tax systems, Republicans have made their task more difficult than it should be. The federal income tax is already progressive; low and moderate wage households pay little in income taxes. But, in relative terms, they still pay a lot of payroll taxes. Cutting that tax is the best way to deliver real tax relief to families that need it most as well as to increase the value of their work effort.
Reprinted from American Enterprise Institute