Some Republicans around Washington are floating an audacious idea: repealing the payroll taxes that fund Social Security as part of a forthcoming tax reform bill. It’s a proposal that, even if it doesn’t cut the program’s funding right now, could have long-lasting aftershocks for one of the pillars of America’s social compact.
We are in the trial balloon phase of tax reform. A lot of ideas are going to pop up in press reports in the coming months, and many or most of them won’t actually end up in whatever legislation the Trump White House and Congress actually propose.
But it’s worth exploring the idea of Social Security payroll tax repeal, which appeared in the Associated Press this week. That would be a very big deal — here’s why.
Remind me: what are payroll taxes?
Pretty much everybody who receives a regular paycheck pays Social Security payroll taxes. They equal 12.4 percent of a person’s income, up to a limit, and they are divided evenly between the employee and the employer. (There is another payroll tax that pays for Medicare, but based on this report, it wouldn’t be affected.)
Why are they such a big deal? Those taxes pay for the bulk of the most popular social program in the United States, which provides essential income to the 66 million people who receive its benefits.
To give you an idea of how crucial payroll taxes are to Social Security’s finances: Americans paid a combined $721 billion in payroll taxes in 2013, about 85 percent of the total revenue brought in by the program. Most people don’t think about them, because these taxes are taken out before you get your paycheck. But if you look at your next pay stub, you’ll see them.
So what’s being proposed?
According to the AP, a Republican lobbyist aligned with the Trump administration is urging the House, where Ways and Means Chair Kevin Brady is leading the tax effort, to repeal the Social Security payroll tax as part of its tax reform bill.
Here’s the original report:
One circulating this past week would change the House Republican plan to eliminate much of the payroll tax and cut corporate tax rates. This would require a new dedicated funding source for Social Security.
The change, proposed by a GOP lobbyist with close ties to the Trump administration, would transform Brady's plan on imports into something closer to a value-added tax by also eliminating the deduction of labor expenses. This would bring it in line with WTO rules and generate an additional $12 trillion over 10 years, according to budget estimates. Those additional revenues could then enable the end of the 12.4 percent payroll tax, split evenly between employers and employees, that funds Social Security, while keeping the health insurance payroll tax in place.
There is a lot to untangle here. The easy part is the repeal of the payroll taxes. This might sound great, but there’s more to it. We’ll get back to that. The monumental change, though, is overhauling how Social Security is funded — from a payroll tax paid in part by workers to a tax paid, at least directly, entirely by businesses.
Why would they do this?
To understand the rest of the proposal, we have to look at another piece of the Republican plan — something called the border adjustment tax, which House leaders really want and are coming up with creative ways to push through.
The border adjustment tax is complicated, but the gist is this: Companies would not be taxed on goods they export out of the United States, but would be taxed on goods they import into the US. It would fundamentally change how American businesses are taxed, prioritizing domestic production. It’s been a big sticking point in the early talks on tax reform, for reasons we won’t get into.
The trouble is, other countries might object to the plan and appeal to the World Trade Organization, which oversees global trade policy. Republican leaders have argued their plan adheres to international rules, but that argument could be put to the test.
This new plan appears to be an attempt to solve that problem, several conservative wonks told me. It changes the border adjustment tax to bring it more in line with the WTO’s rules — we’re veering into extremely wonky territory here, but it would prevent companies from deducting their labor expenses from their taxable income.
That change would increase taxes, which would likely trickle down to workers one way or another. So the plan would simultaneously repeal the payroll taxes to avoid a big tax hike. Whether they would completely offset depends on the details, which we don’t have yet, but that is the general idea.
As the AP report points out, supporters would also probably go a step further and try to sell this as a big middle-class tax cut. But experts agree the effect would actually be minimal.
“If you cut the employees’ payroll tax, then you impose that tax on employers, and you do that in equal and opposite proportions, it has zero economic impact,” Doug Holtz-Eakin, a prominent conservative wonk who leads the American Action Forum, told me. “It doesn’t do anything.”
What about Social Security?
Repealing the payroll tax isn’t a totally new idea. Sens. Ted Cruz and Rand Paul proposed doing it during their presidential campaigns. The big question that must be answered is: If you repeal those taxes, how do you fund Social Security?
The usual answer is more or less the same proposal being reported by the AP, something known as a value-added tax or VAT. The AP report isn’t totally clear about this, but experts I asked on the right and left both interpreted it as putting the new revenue into Social Security to replace the lost payroll taxes.
There’s an argument in favor of it is this, as Scott Greenberg at the Tax Foundation told me:
There are a few potential reasons why a Republican administration could warm to the approach of replacing payroll taxes with a VAT. For instance, generally speaking, one would expect a value-added tax to be both more economically efficient and more progressive than current US payroll taxes. As a result, this could be a policy that appeals to an administration that is interested in economic growth but has also given some indication that it would like to focus tax relief on the middle class.
But the debate doesn’t stop there. Social Security advocates argue that overhauling the program’s finances would undermine it in the long run.
The thinking goes like this: Right now, people feel a strong attachment to Social Security, because they pay into it and receive benefits based on what they paid. If you break that connection, support for the program could erode over time.
“Reducing the linkage between what people pay for Social Security through the payroll tax and the benefits they get out would in the long run weaken public support for Social Security,” Paul Van de Water at the left-leaning Center for Budget and Policy Priorities told me. “And [it would] provide a further rationale for cuts in benefits.”
That’s a hard idea to quantify, but polling suggests that Americans are okay with paying for Social Security because they see it as a valuable program for themselves and others. The uncertainty of how their feelings might change if they don’t pay for it directly anymore is what makes advocates nervous.
Social Security is usually considered untouchable in American politics. So if Republicans actually take up this proposal, expect it to quickly become a big part of the debate.