Payroll tax cut undermines Social Security’s security

The accepted response to the economic deal reached in Congress last week, extending the Social Security payroll tax holiday and unemployment insurance and maintaining reimbursement levels for Medicare doctors, is huzzah!

Finally Congress got something important done with a minimum of brinkmanship and posturing, and more than a few minutes before the deadline. A threat to the embryonic economic recovery was averted, and the extensions even pushed any subsequent fracas over the same issues to the end of this year, safely past the presidential election.

So why should we consider this action cause for despair?

It’s because with every extension of the payroll tax holiday, which was first enacted in 2010, the prospect that Congress will ever restore the tax to its statutory 6.2% of covered income recedes a little bit further over the horizon. And that’s bad medicine for Social Security.

To be fair, thus far the payroll tax holiday hasn’t impaired Social Security’s fiscal resources one bit. By law, 100% of the cut must be compensated for by transfers from the general fund; those transfers have come to about $130 billion since 2010, covering the original “temporary” one-year holiday and a two-month extension passed late last year.

The new extension will require a further transfer of about $94 billion, according to the Congressional Budget Office.

Yet because of the unique features of the program’s financing, tampering with its revenue stream is playing with fire. The payroll tax is currently set at 12.4% of wages, split equally between employer and employee, up to a maximum of $110,100. The tax holiday cuts the employee’s 6.2% share to 4.2%.

Sen. Tom Harkin (D-Iowa) put it well when he excoriated President Obama and his fellow congressional Democrats for approving a measure that places Social Security’s financial stability on the table. “I never thought I would live to see the day when a Democratic president ... would agree to put Social Security in this kind of jeopardy,” he said. “Never did I ever imagine a Democratic president beginning the unraveling of Social Security.”

Even conservatives who aren’t fans of the program’s current structure acknowledge how hard it will be at any point in the foreseeable future to restore the old rate.

“Who is ever going to say, ‘Now the economy’s so strong that it’s the right time to raise taxes’?” Andrew G. Biggs, a former Social Security official who is now a resident scholar at the American Enterprise Institute, told me.

Biggs suggests eventually changing Social Security into a hybrid of a safety net for the needy and a 401(k)-style defined contribution plan for everyone else, but he agrees that a permanent reduction of 2 percentage points in its wage-based revenues would magnify its deficit.

Social Security advocates are even more concerned. “We would like to see an endgame to make sure the dedicated revenues come back,” says Eric Kingson, a professor of social work at Syracuse University and co-director of the Washington advocacy group Social Security Works.

Restoring the old payroll tax rate at a single swipe would mean a sudden increase in the levy of nearly 50%, a change that could be painted by political opponents as a cataclysmic tax hike on the working class, never mind that it’s a rollback of a temporary break.

Treasury Secretary Timothy F. Geithner told the Senate Budget Committee on Thursday, shortly after congressional negotiators cut their deal, that he wouldn’t support extending the payroll tax holiday beyond the end of this year. And not everyone in the policy community is sure that restoring the old rate would be politically impossible.

“I’d be surprised if we don’t return” to the old rate, says Mark Zandi, the chief economist of Moody’s Analytics. Zandi believes a restoration could be bundled together with the expiration of the Bush income tax cuts, which disproportionately benefited the wealthy. “We have a lot of decisions to make about the tax code,” he says.

That doesn’t quell Social Security supporters’ fear that a restoration could also come bundled with some mischief, such as a provision directing the restored 2% into private accounts, a diversion that would permanently undermine the overall program.

The push by the Obama White House and Congressional Democrats to extend the payroll tax holiday placed Social Security’s defenders in a delicate position, as there was wide agreement that continuing tax relief for the middle class and the working class remains crucial to the recovery, notwithstanding signs that employment and consumer spending are picking up.

“The collective psyche is still very fragile, and if we backtrack, all this progress we’ve made will be undone,” Zandi said. In written testimony this month for the Joint Economic Committee of Congress, he projected that failure to extend the payroll tax cut would reduce growth in real gross domestic product this year by 0.4%, and failure to extend the tax cut and unemployment insurance together would cost the economy more than half a million jobs.

Yet viewed as targeted economic relief, the payroll tax holiday is barely even half baked. Washington seems already to have forgotten that it was originally implemented as a substitute for the Making Work Pay tax credit that was part of Obama’s stimulus package enacted in 2009.

That credit was set at 6.2% of one’s pay, up to a maximum of $400 for single people and $800 for couples. The credit topped out at family incomes of about $12,900, was phased out for family incomes between that sum and $150,000 and was eliminated for families with incomes higher than $190,000.

Congressional Republicans flatly rejected extending Making Work Pay. The payroll tax holiday was eventually accepted as a sort of Plan B to get tax relief to roughly the same population. It also may have been seen as a tool to start dismantling Social Security (it doesn’t make sense to tie a tax cut to Social Security’s revenue stream for any other reason). But the tax holiday doesn’t achieve the same ends as Making Work Pay.

The payroll tax cut tops out for individual workers earning more than $110,100 in wages, this year’s income ceiling for the payroll tax. Everyone who is paid at least that much gets the maximum benefit of $2,200, or $4,400 for a couple with two earners each earning more than the ceiling. There’s no phaseout.

As noted here when the payroll tax cut was first implemented in 2010, any couple earning less than $40,000 receive less from the measure than they would have received under Making Work Pay. Nor is there any benefit at all for the unemployed or for the 5.7 million state and local workers who aren’t enrolled in Social Security, as only those with covered wage income see anything.

But the worst aspect of the payroll tax holiday is that it erodes Social Security’s standing as a unique government program with its own revenue stream, a tax dedicated to its upkeep alone. Melding its own revenue with that of the federal government at large chips away at its standing, facilitating no one’s goals except those who want to see the edifice pulled down.

The more the program has to rely on general income tax revenue, the shakier becomes its claim to being a special case among government expenditures. When program-slashers sharpen their axes in Washington, the line has always been drawn at Social Security because it’s funded by a source distinct from the income tax.

If it becomes just another line item in the federal budget, what’s to save it being swept up in an across-the-board orgy of spending reductions? Hey, we’re taking a few billion out of defense, a few billion out of highway construction, a few billion out of benefits for the elderly and disabled — that’s fair, isn’t it?

“If the holiday doesn’t automatically expire,” says Kingson, “you’re risking long-term economic security for a short-term economic gain, however important that is. We hope people understand that.”

Michael Hiltzik’s column appears Sundays and Wednesdays. Reach him at mhiltzik@latimes.com, read past columns at latimes.com/hiltzik, check out facebook.com/hiltzik and follow @latimeshiltzik on Twitter.