Good politics — what helps get you elected — is frequently bad policy. The latest example is the payroll tax "holiday," which will expire in about three weeks unless Congress acts.
Lawmakers shaved 2 percentage points off the payroll tax, reducing the annual tax bill of a typical worker by some $1,000. The goal was to provide another economic stimulus, but it would be hard to make a convincing case that it worked. Last year, the economy grew by 1.7 percent. Meanwhile, the tax holiday added another blob of red ink to the federal deficit.
What many fail to appreciate is that the tax holiday has also boosted the case for long-term Social Security reform because it has highlighted the reality that this program is no longer self-supporting.
Last year, the Social Security trustees announced that the program had gone cash negative permanently, meaning revenue from the payroll tax can no longer fully pay for benefit checks. The shortfall was about $46 billion, which increased the federal deficit by the same amount. That followed a shortfall of similar size in 2010.
The payroll tax holiday will reduce Social Security revenue by an additional $105 billion for the full year — deficits that must be made up by transfers from general revenue.
The payroll tax holiday is also destroying the myth of the trust fund.
There are still people out there who believe the Social Security trust fund contains economic assets that can be used to pay for benefit checks. Senate Majority Leader Harry Reid, for example, says no action on Social Security is needed until “two decades from now.” If so, why was it necessary for Treasury to transfer cash to Social Security to cover its costs? Why didn’t the feds simply dip into the trust fund, stashed with $2.6 trillion in Treasury bonds?
The reason is that the bonds can’t be redeemed unless Treasury raises taxes or borrows or unless Congress cuts spending elsewhere. Economically, it wouldn’t make any difference if the fund didn’t exist.
Politically, though, it’s important. As long as a sufficient balance exists in the fund, Social Security is legally authorized to pay whatever Congress defines as full benefits. If the balance falls below what’s needed, the program can only pay what it receives from the payroll tax. Social Security isn’t “insurance.” It’s pay as you go: today’s revenue finances today’s benefit checks. Nor do recipients receive money they paid in when they were working, contrary to what some believe. They receive money from today’s workers.
The trust fund’s primary purpose is to shield Social Security from competition with other budget priorities. As long as the program was self-financing and “backed up” by a trust fund, opponents of reform could snarl, “It’s working fine. Keep your hands off.”
But thanks to the payroll tax holiday and the now-perpetual cash deficits, no informed person can claim it’s working fine. The federal government has a lot of other important priorities besides Social Security, such as Medicare, Medicaid and national defense. If Social Security is drawing more than $150 billion a year from general revenue in addition to its funding from the payroll tax, why shouldn’t it compete with other priorities for scarce tax dollars?
Thanks to the misguided payroll tax holiday, it will be harder for the program’s defenders to avoid questions like that. It’s also harder to make the case that Social Security doesn’t need to be reformed.
Even if the payroll tax holiday expires, in eight years the cash deficit is expected to be more than $80 billion — triple that by 2030. More people, especially younger workers angry about rising taxes, will be calling their lawmakers, wondering why this program is allowed to grab money from both the payroll tax and the Treasury.
If Social Security can again be made self-supporting long before then, that question isn’t likely to come up — which is why it makes sense to reform it now and ensure that it’s stable in the future.
If it were up to me, I’d let the payroll tax cut expire. But then, I don’t have to run for office.