Economics, Entitlements

How Many Times Should We Rebate Payroll Taxes for Low Earners?

Over at e21, Chuck Blahous—the Bush White House’s point man on Social Security and now a public Trustee for Social Security and Medicare—discusses a Social Security reform proposal from the Committee for a Responsible Federal Budget, which is designed as a middle-ground plan that could achieve some level of consensus on reform.

I agree with Chuck that for what it aims for, the CRFB plan is a good one. The plan would increase the early and full retirement ages, correct the Consumer Price Index for its overstatement of inflation, reduce benefits for middle and high earners, add a minimum benefit to Social Security, establish universal retirement savings accounts on top of Social Security, and make the payroll tax more progressive.

It’s this last part I wish to focus on. To offset the costs of the add-on accounts, the plan would eliminate the payroll tax on the first $4,500 on individual earnings. To make up for this, the maximum taxable wage on which payroll taxes are levied—currently $106,800—would be increased. I understand the logic, but wonder if at some point these efforts go too far.

After all, the Earned Income Tax Credit was explicitly designed to rebate payroll taxes for low-wage workers. On top of that, the Obama administration’s “Making Work Pay” tax credit also aimed to rebate the employee share of the Social Security tax. So we’ve effectively already rebated those taxes twice.

The tax component of the CRFB plan would be the third time the government would rebate payroll taxes for low earners. Given that low- and even middle-income earners pay next to no income taxes and that low earners receive generous Social Security benefits relative to the payroll taxes they do pay, I’m just not sure we need to take this extra step. Financing that rebate means a higher taxable maximum wage, which would increase marginal tax rates in the applicable range by around 10 percentage points, which is a pretty big deal from the standpoint of economic incentives.

More broadly, I think we need to get beyond some of the rationales we have for not doing things we need to do. People today can’t afford to save? In the past most people were much poorer, yet they saved more. People can’t work longer due to health concerns? Yet in the past, when jobs were harder and healthcare poorer, the typical person retired later than he does today. I’m not saying we don’t need to have concern for low earners—after all, concern for low earners is a major reason we have a Social Security program—but we also need to be reasonable in terms of spreading the costs of reform over the full population.

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