Why Trump’s payroll tax deferral won’t aid the recovery, but could help cripple Social Security

You may have heard that the president’s executive order for a payroll tax deferral went into effect on Sept. 1. It has raised a lot of questions, including: Will it help the economy and/or will it bankrupt Social Security? More than likely, it will have little impact on the recovery, but it could cause even more damage to the already deteriorating Social Security Trust fund.

First, what is a payroll tax? You probably know these as FICA, the Federal Insurance Contributions Act taxes that include both Social Security and Medicare taxes. If you earn wage or salary income, you pay the tax, no matter how little you make.

The Social Security tax rate is 6.2%, paid both by the employee and the employer, for a total of 12.4%. In 2020, the taxes are taken out from the first $137,700 of income, after which no additional taxes are paid. Those funds go into the Social Security Trust Fund to support Social Security payments.

As for Medicare, the rate is 1.45% for both employee and employer, but there is no maximum. Above $200,000, there is an additional 0.9%.

The president’s executive order affected only the Social Security portion of the payroll taxes and just for employees. The deferral will last until the end of the year.

Critically, this is not a tax cut — it is a tax deferral. During the first part of next year, employees will have to repay the amount deferred.

And that is the rub: Workers could face a potentially major tax increase early in 2021, when they go back to paying the regular 6.2% tax and also pay back the 6.2% that was deferred.

But there is another troubling issue with this tax deferral plan: Employers are ultimately responsible for paying the deferred taxes to the government.

Companies such as restaurants with huge worker turnover will have to find those formerly employed workers and get the money from them or their new employers. Good luck with that.

If an employee retires, quits, changes jobs, dies or whatever, getting the deferred taxes from them is likely to be nearly impossible.

So, what will firms probably do? The logical thing is to just not participate in the program. They cannot be compelled to do so.

About the only workers who will definitely get the deferral, whether they want it or not (they may not want to have to pay much higher payroll taxes early next year), are federal government employees. It would look awfully bad if the government itself opts out of the president’s initiative.

Thus, not a lot of workers may even see their payroll taxes deferred, so the gains to income and spending could be modest.

For other reasons, as well, the tax deferral may not lead to significantly greater economic activity.

It is unclear how much of the deferred taxes will be spent. Actually, a large portion could wind up in savings. The beneficiaries of the deferrals know they must repay the reduced taxes through higher tax payments early next year. That is a disincentive to spend all the deferred taxes this year.

Finally, as economists have pointed out, those who are working are not the ones in need. If you weren’t laid off, you are doing OK. Those who were laid off but rehired may have faced financial pressures, but the enhanced unemployment compensation offset much of their income losses.

Instead, the money would have been better used if it went to those not working. They need the most assistance. It could have helped pay for additional enhanced unemployment payments. It is clear from the data those funds supported household spending this spring and summer.

To answer the first question, the economic impact on spending will be limited, at best.

What about the potential for harming the Social Security Trust Fund? That depends upon how much tax is actually deferred and ultimately, how much of that deferral is not repaid. If it is all repaid, no harm, no foul.

In addition to businesses not repaying the deferrals, there is concern that Congress and the president will decide that requiring all those voters to repay the deferred taxes is not a politically smart thing to do. Section 4 of the executive order did state: “The Secretary of the Treasury shall explore avenues, including legislation, to eliminate the obligation to pay the taxes deferred pursuant to the implementation of this memorandum.” If that occurs, the no-longer-deferred taxes are lost to the Social Security Trust Fund.

Unfortunately, the Social Security Trust is already in deep financial trouble. The Congressional Budget Office, the nonpartisan economic arm of all members of Congress, reported recently that the Social Security retirement fund would turn negative in 2031.

The more the Social Security Trust Fund revenues are reduced as a consequence of the deferred tax plan, the sooner it becomes insolvent.

While the tax deferral, by itself, would not cause Social Security to go broke, it could worsen the financial problems by shortening the time before insolvency occurs and/or increasing future taxes needed to pay for the shortfall.

The economy is still not strong enough to stand on its own. It needs additional stimulus. But that stimulus should be targeted to households and businesses that actually need it. Providing a temporary tax reduction that helps those who are not in the greatest need, while providing an incentive to not spend the money because it must be repaid, is not the way you stimulate the economy.