Clinton May Cut Payroll Tax to Spark Economy

If you read between the lines, it is clear that President-elect Clinton is ready to prod the economy by reducing the payroll tax--the amount deducted from paychecks for Social Security.

Doing so would increase take-home pay for more than 80% of the nation’s workers and give a strong jolt to consumer spending.

Nothing has been formally announced, but Clinton tipped his hand at a press conference Monday when he spoke about “how regressive the tax system has become. . . . We’ve had six payroll tax increases which have fallen almost exclusively on people with incomes of $52,000 and less. . . . I would like to provide some tax fairness.”

Clinton cited Senate Majority Leader George Mitchell (D-Me.), who has spoken out frequently on the Social Security tax, as an ally. And there is widespread support in Washington. “If you want middle-income tax relief, that’s the way to do it,” a congressional aide says.

The idea has logic. Social Security taxes actually have risen seven times since 1980--from 6.13% to 7.65%--and since they are levied on the first $55,000 of income, the impact has fallen disproportionately on middle-income wage earners.

But tax cuts present difficulties in a time of huge federal deficits--and may demand offsetting tax hikes. Clinton hasn’t said much about offsets--although he plans to raise some taxes.

Ironically, says a Washington insider, Clinton seems bent on modeling his Administration on that of Ronald Reagan--”lower taxes first, ask questions later.”

As usual, there are hopeful policies and reluctant trade-offs, and to appreciate them you must first understand why payroll taxes are rising--and how Social Security makes the federal deficit seem smaller than it really is.

Social Security taxes, by which active workers finance the retirement of previous generations, rose in the 1980s to build a reserve for the next century, when the unusually large baby boom generation--the 70 million people born between 1946 and 1962--enters retirement and starts collecting benefits.

That reserve is growing today because there are many more people working than retired; it is now $300 billion--and rising at about $50 billion a year.

The surplus is invested in Treasury securities, which lowers the federal government’s dependence on global bond markets--meaning that the reserve keeps interest rates a bit lower than they might be.

But there is difficulty because the Treasury is using an accounting gimmick to disguise the fact that it is borrowing from the future.

When the government reported a deficit of $290.2 billion for fiscal 1992, which ended Sept. 30, it included as income that year’s surplus funds in the trusts for Social Security, highways and airports and government employees retirement--a total of $96 billion, according to the Congressional Budget Office. So it could be said that the federal deficit for fiscal ’92 was actually $386 billion.

That looks like phony accounting, and Clinton suggested as much Monday when he said “we hope the deficit hasn’t been understated. . . . We’re trying to get to the bottom of the figures.”

And, yes, it is phony because money in a retirement fund is being borrowed for current expenses. “If the reserve were truly for retirement, it would be set aside and not put into the general fund,” says economist Barry Bosworth of the Brookings Institution, an authority on Social Security.

In a sense, Americans today are like parents who set up a savings account for the kids’ education but dip into it every Saturday night to party. When the tuition bills eventually arrive, the parents may scrape together the money, but it will be harder than if they had saved.

The Social Security surplus being spent today won’t be there in 2025, when millions retire, and there will be virulent demands to raise taxes on the active workers of that day.

And more than future trouble is involved. The Social Security taxes that are being used to finance current government are inequitable. Workers earning less than $55,000 pay more than their fair share, while nothing is paid on wages above that figure--except for a new 1.45% tax to support Medicare.

So payroll deductions for Social Security are a regressive tax, and Clinton and Mitchell are right to want to lower them. Whether the bond markets send interest rates soaring because the deficit will rise is another story.

Clinton proposes to raise some taxes. “He’ll bring roughly $14 billion a year into government revenues by hiking taxes on incomes over $200,000,” says Margo Thorning, a tax expert at Washington’s Council for Capital Formation. But other tax reductions, such as the investment tax credit, may offset that hike in revenue.

The payroll tax reduction could well be a net stimulus to the economy, of a kind not seen since Reagan’s first term began in 1981 or Kennedy’s in 1961.

The Democratic President may identify more with Kennedy than Reagan, but no matter. The important point is that his economic policies, like theirs, will be to go for growth.

Security and Opportunity?

The rate at which Social Security taxes are deducted from paychecks has gone up seven times since 1980--and income subject to the tax continues to rise every year. It is that Social Security tax rate that President-elect Bill Clinton may lower to give the middle class a break. Source: Social Security Administration