The Problem with “Payroll Tax” Cuts

As Congress debates a third round of the so-called “payroll tax cut,” more members have at least begun to acknowledge that this tax is what pays for social security. In fact, it is much more commonly referred to as the “social security tax,” the label used on my pay stub, and probably on yours as well. The first two times, hardly anyone in Congress even mentioned that this had anything to do with social security.

The problem, of course, is that the social security trust fund is predicted to run out in 2043. With less money in, it will run out sooner – unless the money lost through the tax cut is replaced by money from somewhere else. This time, at least, the President’s proposal is to replace the funds with a new tax on those with annual incomes greater than $1,000,000.

At this point, extending the tax cut is probably a good idea, if it’s paid for. While I don’t think the original cut provided much of a stimulus, ending it would take money out of everyone’s pocket, and probably would hurt the economy. However, there are some problems, and we should all be aware of them.

Social security falls into the broad category of social welfare: government programs that help everyone maintain at least a minimum standard of living. However, there are two kinds of social welfare program, often classified as social insurance and social assistance.

Social insurance programs are paid for by individual contributions, usually in the form of a tax. People become eligible for the benefits by participating in the contributions. Social security and Medicare are social insurance programs, as is unemployment compensation (with the proviso that the tax in this case is paid by the employer, not the employee).

Social assistance programs are paid for by general revenues.┬áPeople become eligible for the benefits because of economic need. Medicaid and Transitional Assistance for Needy Families (“welfare”) are social assistance programs.

So there are two important differences between social insurance and social assistance. The former is contributory and universal; the latter is noncontributory and means-tested. However, there is another important difference, generated by the first two: social insurance programs are popular, while social assistance programs are not.

The popularity of social security and Medicare come from the feeling that we have earned them. By paying into them over the years, we create a sense that we are getting back something we paid for. This makes it very hard for anyone to suggest repealing them. “Welfare” and Medicaid are far less popular; in fact, TANF has been almost eliminated, and Medicaid is cut whenever there is a budget crisis.

The risk in changing the tax basis for social security is that it will come to be seen as a social assistance program, one that taxes the rich to pay the poor. Obama’s proposal does not get us there, but it is a small step in that direction. We should proceed with caution.