With a sturdy job market, healthy consumer balance sheets, and low inflation, the economy is probably not headed toward a recession. But to continue America’s prosperity and guard against a potential economic slowdown caused by the ongoing trade war with China, President Trump should lower one of the most oppressive of all federal taxes — the payroll tax.
The payroll tax is imposed on both employees and employers to fund Social Security, Medicare, and other social-insurance programs. Since 1955, the basic payroll tax has nearly quadrupled from 4 percent to 15.3 percent. Today, almost 70 percent of taxpayers pay more in payroll taxes than they do in federal income taxes. Altogether, the typical worker pays nearly twice as much in payroll taxes as in income taxes.
Despite the much-needed income-tax and corporate-tax cuts from the 2017 Tax Cuts and Jobs Act, the payroll tax continues to impose a heavy economic burden on workers and small businesses. The maximum Social Security payroll tax for a single-earner family is now a whopping $7,960 annually. Moreover, payroll taxes are highly regressive, with the bottom fifth of households paying 6.9 percent on average while the top 1 percent pay 2.3 percent, according to the Tax Policy Center.
It would be a mistake for President Trump to waffle on his administration’s reported consideration of cutting the payroll tax. A reduction would increase take-home pay for millions of workers, shrink the cost of labor for businesses (especially smaller businesses), and provide insurance against a downturn: According to economist Mark Zandi of Moody’s Analytics, every $1 reduction in payroll taxes would increase gross domestic product by 80 cents.
President Trump should propose exactly what President Barack Obama did in 2011: a temporary reduction in the Social Security portion of the payroll tax from 6.2 percent to 4.2 percent. This would provide significant tax relief for the average worker while counteracting the economic toll imposed by the administration’s tariffs on U.S. imports from China, which cost the average American household $600 annually, according to an estimate by JPMorgan Chase.
While a payroll-tax cut would temporarily enlarge the federal budget deficit, the positive impact of such a cut on jobs and growth would likely keep the actual figure below the static revenue cost of $150 billion a year. It would be wise to weigh any temporary increase in the deficit against the more damaging costs of slower economic growth; according to the Office of Management and Budget’s economic rules of thumb, a sustained 1 percent lower real GDP growth would increase the budget deficit by $800 billion over ten years
Regarding potential concerns about the impact on the Social Security Trust Fund, such a temporary reduction is unlikely to have significant lasting impact. Any immediate small blow to the fund would be mitigated by the long-term protection against recession provided by the tax cuts. Ultimately, forward-thinking reforms to the Social Security program would allow Americans to invest a portion of their payroll taxes into personal retirement accounts. Instead of letting the temporary payroll-tax cut go back to the government when it expires, the money should be redirected into personal retirement accounts, as suggested by the Institute for Policy Innovation. This proposal would produce higher returns for future retirees and put the Social Security program’s long-term finances on sounder footing by offsetting most of the program’s future liabilities for today’s workers.
A payroll tax cut should not be a partisan issue. In 1990, my then-boss Senator Robert W. Kasten Jr. (R., Wis.) teamed up with Senator Daniel Patrick Moynihan (D., N.Y.) on payroll-tax-cut legislation that garnered the support of the National Federation of Independent Businesses and the AFL-CIO. Though he has typically been reluctant to follow his predecessor, President Trump has the opportunity to improve on President Obama’s 2011 effort with a cut of his own.
We do not need to wait for wholesale reform to allow Americans to keep more of their hard-earned money, which would boost the economy, increase take-home pay, and create jobs. Cutting the payroll tax is a smart hedge against any future economic distress and a powerful tool for extending our already unprecedented economic prosperity into the future.