Friday, January 2, 2009

Larry Lindsey: Cut payroll tax to stimulate economy

Former Federal Reserve Governor and Bush economic advisor – and current AEI visiting scholar – Lawrence Lindsey argues in the Weekly Standard for a 50 percent reduction in the payroll tax with revenue losses filled with a new carbon tax. I've been skeptical of payroll tax cuts before, but there's something here that I find interesting.

I've argued previously that Social Security's future shortfalls are really a function of over-generosity to past participants, who collected something like $17 trillion more in benefits than they paid in taxes. Diamond and Orszag call this the "legacy debt."As a result, current and future participants will have to collect $17 trillion less in benefits than they'll pay in taxes. In other words, this $17 trillion is a "pure tax," meaning that we'll pay that amount in but receive no benefits back in return.

One idea I've been playing with is to separate out the pure tax element of Social Security financing, funding it with a new tax instead of through the payroll tax. The idea here is a) to fund this legacy debt through the most efficient tax possible, which probably isn't a tax on labor; and b) to make clearer to Social Security participants what's happening with their money. While the tax to fund the legacy debt won't bring them any new benefits, the remaining Social Security tax would pay a market rate of return, rather than the below-market returns paid today.

Lindsey's proposal is consistent with this idea. The $17 trillion shortfall is equal to just around 6.2 percent of all future payroll, meaning that Lindsey's idea to cut the $12.4 percent payroll tax in half and fund the legacy debt with a carbon tax is equivalent to funding the Social Security legacy debt through the carbon tax. However, under Lindsay's plan future Social Security benefits would still need to be reduced to a level affordable within 6.2 percent of payroll.


William said...

I have calculated that the SS-OASI benefit could be paid out of a 6% payroll tax if fully funded, meaning that those who are 21 would pay 6% up to age 67 and then be paid a SS-OASI benefit based on the current SS-OASI benefit formula. In fact 6% is a bit high. Based on earning the US Treasury Rate of 5.5%, the actual tax falls between 5.5 and 5.8%. A payroll tax of 6% would cover the cost.

The $17 Trillion is far more than 6.2% of payroll. To pay SS-OASI benefits in full requires the SS-OASI tax (not including SS-DI) to rise to just under 19% by 2040. This rise in the payroll tax is equal to the shortfall or unfunded liability in the SS-OASI "TRUST" fund. The Shortfall in terms of a tax is more on the order of 9 to 10%. Inf act if you were to cease bernefits to all those under age 45, the payroll tax would still have to be over 6.35% for all until the last eligible person who was 45 when it took affect passed on. If you move the age forward to age 21, the payroll tax rises to 8.8%.

Keep in mind the table was created in 1999, ten years ago. The major change has been in the size of the fund to pay benefits. This column has more than doubled. Subtract off the $2.2 trillion in the SS-OASI trust fund now and you get a good idea of the mess it is in.

What surprises me is that when I have proposed eliminating the 10.6%SS-OASI tax (since 1983), many laughed. Now some are seriously considering a payroll holiday of two months. If two months are good, why not longer? If 6.3% is good, why not 10.6%?

The payroll tax is responsible for the slowing velocity of money through the economy by first increasing the need for longer term mortgages, credit cards and lower savings. The way you back out of a mess like we are in is to follow the path that got us into it. Eliminate the payroll tax, allow workers to save, pay for college, save for retirement, obtain shorter term mortgages and pay for their own healthcare.

Addiction to government handouts is killing us all. Its time to kick the addiction and just say no to Social Security!

As the years have passed, the intensity of the debate over SS-OASI has gone from barely audible to a loud roar. Two sides are being formed. In the near future, we will see two determined sides materialize with grey area between them. Which side will you be on?

Andrew G. Biggs said...

$17 trillion is the present value shortfall over the infinite horizon, and the present value of taxable payroll over the infinite horizon is $277 trillion (see, Table IV.B.6, footnotes).

d said...

cut the social security tax in half and remove the Cap. 100% of the CEO's 10 million comp