You CAN have it both ways – If you’re talking about different things

posted at 2:08 pm on December 15, 2011 by J.E. Dyer
[ Taxes ]   

Jazz Shaw and Ed Morrissey have a debate going over what would be a consistent political position for Republican lawmakers, as they consider (a) the payroll tax holiday set to expire on 1 January 2012, and (b) the income tax rates scheduled to increase on 1 January 2013.

Jazz argues that it’s inconsistent to make the economic impact of a tax hike the overriding concern when it comes to income tax rates, but dismiss the economic impact of an increased tax load when the subject is ending the payroll tax holiday.  He points out that the Bush tax rates were passed with an expiration date, and therefore were temporary in a sense similar to the scheduled expiration of the payroll tax holiday.

There is an extent to which this argument is valid, but it’s a very limited one.  The reason is quite simple:  the two tax issues are different.  They are different on both the paying and the receiving end — and in their impact on the economy.

Income taxes are paid on “taxable income” from earnings (wages, salaries, dividends) and annuities (e.g., retirement plans).  The rate of taxation goes up as taxable income increases.  That’s on the paying end; on the receiving end, income taxes provide the largest single source of general revenues for the federal treasury.

Payroll taxes – Social Security and Medicare – are paid on base salary.  The rate is the same for all income levels (currently 7.65% for an employee, matched by his employer; 15.3% for self-employed), up to the maximum taxable earnings figure, which this year is $106,800.  (It is going up next year to $110,000.)  The payroll tax holiday has reduced the withholding for the self-employed and for employees – not for employers, who still pay their 7.65% per employee – by 2 percentage points.  On the receiving end, the payroll tax revenues go to the Social Security and Medicare trust funds.

Basically, those who are fine with ending the payroll tax holiday are simply asking workers to go back to making their full contribution to the Social Security and Medicare programs.  Jazz is correct in saying that this will mean more current money out of the pockets of taxpayers who earn up to $110,000 a year.  For that $110,000-a-year earner, the payroll tax bill will increase by $2200, or about $180 a month.  It will increase by less at each lower level of income.

An increase in the income tax rate – and in particular, the expiration of the Bush tax code – would have a more significant economic impact, in that it would hit everyone from lower-middle to the highest income levels with an increased tax load.  Besides reinstituting the “marriage penalty” and reducing child tax credits, an expiration of the Bush tax code would tighten tax brackets – subjecting people in the lower-middle and middle range to a higher rate – and increase the rate on higher incomes and capital gains.

These latter effects are the ones that suppress economic expansion the most. Short of violating the laws that protect everyone, you can’t make the rich poor by taking their money from them – but you can force them to restructure their finances so that it’s less taxable.  The rich can choose to take less income, hold assets in the least-taxable forms, put their money overseas, and so forth.  And every time they do, they invest and spend less in the US.

The payroll tax doesn’t affect these dynamics of the economy.  Of course, for those with the FDR-era Keynesian view that consumption drives the economy, the idea that wage-earners will see an average total of $1000 less in their paychecks next year (about $83 a month) means taking that $1000 per earner out of circulation for consumption purposes.

Those who see it differently would point out that the payroll tax holiday has already cost Social Security $105 billion in revenues – and it has done that in the first year in which Social Security paid out less than it took in.

Social Security is a separate program; unlike the all-but-unintelligible situation of general revenues and expenditures, with Social Security, we can tell what effect we’re having on the program by paying less into it.  But if having to contribute to Social Security is too much of a burden on us, then let’s restructure it already, and schedule transitions to a different basis for the program in the future, while keeping our commitments to today’s seniors and those close to retirement.

What smart earners have been doing with their payroll tax holiday savings is, well, saving.  Or, very possibly, investing.  We’ve had the holiday for a year now, and it hasn’t had any noticeable accelerating effect on consumption, or on the economy as a whole.  If it’s that important to have a payroll tax holiday, then let’s go big.  Let’s have a payroll tax holiday of 5 percentage points for 10 years, suspending federal taxes on investment returns from the amount previously withheld; and let’s reform Social Security and Medicare at the same time.  In 10 years, we can have a viable plan for the future of both programs, putting them back on a “needs” basis and leaving more current money in the pockets of earners, because the programs can be paid for out of general revenues, and perhaps – if necessary – a 1-2% payroll tax.

And we’ll have a whole lot of people with bigger, better investments for their own futures – and a whole lot of investment capital built up for the economy.

J.E. Dyer’s articles have appeared at The Green Room, Commentary’s “contentions,” Patheos, The Weekly Standard online, and her own blog, The Optimistic Conservative.

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