The Trump administration is reportedly considering a payroll tax cut for American workers in an effort to bolster consumer spending and stave off a possible recession. USA TODAY economics reporter Paul Davidson explains what the tax is and whether a cut, which would have to be passed by Congress, would boost the economy.
What are payroll taxes?
Payroll taxes come out of the paychecks of the vast majority of American workers and are used to finance Social Security, Medicare, unemployment insurance and other social safety net programs. The payroll tax that would be cut is the one that funds Social Security programs. That generated $855 billion last year, according to the Peter G. Peterson Foundation, which addresses fiscal problems.
How much is that tax and how much would it be cut?
The portion that pays for Social Security is 6.2% of wages. It’s not clear how much that would be reduced but one possibility is that the cut would be the same as the one enacted by the Obama administration in 2011 and 2012, which would lower the tax to 4.2% of wages.
What would the cost be?
An employee payroll tax cut from 6.2% to 4.2% would cost about $150 billion a year in revenue for the Social Security trust fund, according to the Committee for a Responsible Federal Budget. Under the Obama administration, the federal government made up the roughly $100 billion in added yearly cost from its general fund. So Social Security programs remained fully funded and the lower taxes increased the deficit.
How significantly would a payroll tax cut lift consumer spending and the economy?
Payroll tax cuts immediately result in bigger paychecks. Everyone receives a similar cut and low- and middle-income workers in particular tend to spend most of that income. As a result, each $1 cut in payroll taxes would increase gross domestic product by 80 cents, according to Mark Zandi, chief economist at Moody’s Analytics. By contrast, the GDP boost from a personal income tax cut is just 65 cents per dollar spent since much of the benefit goes to higher-income taxpayers who mostly save their increased earnings, Zandi says.
In 2011, the payroll tax cut added a notable half percentage point to economic growth, Zandi estimates, pushing the annual GDP gain to 1.6%. But with unemployment near a 50-year low at 3.7%, there are fewer available workers to produce goods and services now than there were in 2011 and so the lift to GDP growth would likely be somewhat less, Zandi says. Economist Greg Daco of Oxford Economics estimates a similar payroll tax cut now would add about three-tenths of a percentage point to growth.
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Would a payroll tax cut be worth the rise in the deficit?
Several prominent economists say no. In 2011 and 2012, the economy was still struggling to emerge from the Great Recession of 2007-09, unemployment was high at 8% to 9% and wages were barely growing, Zandi says. Now, unemployment is at historic lows and wages are rising solidly.
What’s more, Daco says, consumer spending generally has been strong and doesn’t need a B-12 shot. And with recession worries growing, it’s questionable whether consumers would really spend the windfall in their paychecks, he says.
Meanwhile, a payroll tax cut would add to an annual deficit that’s expected to hover around $1 trillion over the next decade and already has swollen as a result of the federal income tax cuts Congress passed in late 2017. Big deficits, and the total $22 trillion national debt, could make it harder for the government to pass big spending measures to dig the country out of the next recession.
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“It’s a step in the wrong direction when debt is already at a record high,” says Marc Goldwein, senior vice president of the Committee for a Responsible Federal Budget.