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.