When I was younger, a family friend gave us a pile of old dresses. Hand-me-downs weren’t new to us, and my mom was an amazing seamstress who could make almost anything look terrific (she handmade both of my prom dresses and most of my church dresses). But I didn’t have my mom’s talent. I was, at best, good at shortening a hem or two, or removing a ruffle. But in my head, I was capable of Dior-level alterations. And when I saw a particular green and blue floral dress, I had visions, but no real plan, of modernizing it a la Andie Walsh (Pretty in Pink) into a head-turner.
When I was done, I didn’t have the kind of dress that kids on dance floors would part to gawk at: I had an ill-fitting dress with odd cut-outs. Sometimes, your intentions aren’t good enough. Hacking away at something in an effort to fix it – even if the creation wasn’t that great to begin with – doesn’t always make it better.
That’s exactly how I feel about President Trump’s efforts to push through a temporary payroll tax cut in the next stimulus package. At a recent White House briefing, when asked how important the payroll tax was, President Trump replied:
I think it’s very important. I think it’s a very important thing. It’s very good. It’s been proven to be successful. It’s a big saving for the people. It’s a tremendous saving, and I think it’s an incentive for companies to hire their workers back and to keep their workers. So the payroll tax cut, to me, is very important. We’re working on it. And I don’t think that there’s too much dispute as to the level of importance, John.
It’s a very important thing. Okay? It’s one of — that’s one of many elements we’re discussing. We’re discussing probably a total of 10 different elements. But payroll tax cut is a very important one.
If that sounds like deja vu, you’re not wrong. As the economy wobbled last summer, President Trump pushed for payroll tax cuts in 2019 in response to concerns that the country might be headed for a recession. As he did this year, President Trump confirmed at the time that payroll tax cuts were on the table in 2019, along with rumored potential changes to capital gains, saying, “I’ve been thinking about payroll taxes for a long time. Many people would like to see that.”
Neither of those things happened. So far.
The last payroll tax cut for American workers was pushed through by the Obama administration in 2011, despite concerns that the cut would increase the federal deficit. The theory was – as now – that the benefit would offset any costs. After the first round, Congress renewed the temporary payroll tax cuts in 2012.
Here’s how the payroll tax cuts worked. Wages and self-employment income are subject to Social Security and Medicare taxes. Together, Social Security and Medicare taxes are known as FICA (Federal Insurance Contributions Act) taxes and are taken right out of your paycheck. Taxes on self-employment income are separately referred to as SECA (Self-Employment Contributions Act) taxes since self-employed persons pay both the employee and employer contributions.
If you’re employed, you pay Social Security tax (6.2%) as the employee, and your employer also pays the same rate of tax (6.2%); again, if you’re self-employed, you pay both portions.
Unlike Medicare, Social Security taxes are subject to a wage cap. In other words, you pay Social Security taxes on your earnings until you hit a magic number. After that, your wages are no longer subject to Social Security taxes. For 2020 that magic number is $137,700. That means that whether you make $1,000 or $100,000, you will pay Social Security taxes on that income. But if you earn $137,701? You’ll pay Social Security taxes on $137,700, but not on the extra dollar. And if you earn $1,137,700? You’ll pay Social Security taxes on $137,700 but not on the extra million.
In contrast, all wages are subject to Medicare taxes. If you’re employed, you pay Medicare tax (1.45%) as the employee, and your employer kicks in tax at the same rate (1.45%). As before, if you’re self-employed, you’ll pay both portions. And, thanks to a change in the law which took effect in 2014, high-income taxpayers are also subject to a Medicare surtax (0.9%) tacked on to wages that exceed $200,000, or $250,000 for married taxpayers.
Your employer collects those Social Security and Medicare payments and remits them to the government on your behalf (or you pay them directly if you’re self-employed). These taxes are sometimes referred to as “trust fund” taxes and are credited toward your retirement benefits. You can find out more about trust fund taxes here.
With that, here’s how the 2011 payroll tax cut worked. On the employer side, payroll tax contributions for federal purposes remained the same. On the employee side, payroll tax contributions for federal purposes were reduced by 2%: Instead of paying in at 6.2% for Social Security taxes (up to the cap, which was, at the time, $106,800), contributions were 4.2% for Social Security taxes (still up to the cap). Self-employed persons also got a 2% reduction. Contributions for Medicare remained the same.
So why wouldn’t a similar payroll tax cut make sense now? Here are a few reasons:
- Payroll tax cuts aren’t useful for the unemployed. Even if the payroll tax applied to employers and employees, it wouldn’t provide immediate assistance to those who are not receiving a paycheck. According to the Bureau of Labor and Statistics, the national unemployment rate declined to 11.1% but remains 7.4 points higher than June 2019. That represents more than 17 million Americans who are out of work.
- Payroll tax cuts won’t help retirees. One of the reasons that the stimulus checks were so popular is that almost everyone got one, including retirees. Payroll tax cuts won’t offer any relief to seniors who are on Social Security or retirement.
- Payroll tax cuts generally benefit higher earners more than those at the bottom. Senate Majority Leader Mitch McConnell (R-KY) has signaled that a relief package should also target those at the bottom, but a payroll tax cut wouldn’t accomplish that. Assuming that the payroll tax cut was similar to the 2011 cut, and lasted through the end of 2020, it could save top wage earners up to $1,377 through December. Those in the middle would save in the neighborhood of $521, and those making minimum wage would save a total of $151 for the remainder of the year (based on data from the Bureau of Labor and Statistics for the quarter, downloads as a PDF).
- Payroll tax cut savings are generally small compared to the administrative burden required to educate employers and revise payroll tax forms. If the payroll tax cuts are intended to last through 2020, the overall savings are pretty small. As noted above, a 2% cut for minimum wage earners would only net those workers about $151 total, or around $20/month. Stimulus checks were significantly more. And a check was a one-time payment from the government, while a payroll tax cut will require changes to payroll tax forms and systems, and adjustments for workers.
- Payroll tax relief already exists for employers. It’s unclear whether the proposed payroll tax cuts would apply to employers and employees, but the talking points sound like they might apply to both. While the idea is to allow employers and employees to keep more cash in pocket, that option already exists for employers. Under the CARES Act, employers may defer the deposit and payment of the employer’s portion of Social Security taxes. The deferral applies to deposits and payments of the employer’s share of Social Security tax that would otherwise be required to be made during the period beginning on March 27, 2020, and ending December 31, 2020, with half being due on December 31, 2021, and the remainder due on December 31, 2022. The relief also applies to self-employed persons.
- Payroll tax cuts are expensive. According to the Congressional Research Service, the last payroll tax cut cost over $200 billion. Typically, to keep Social Security and Medicare in the black, Congress would fill any holes with money from the general fund. Some fiscal conservatives aren’t convinced that’s prudent, including Sen. John Cornyn (R-TX), who warned, “I think it’s problematic, because obviously the trust funds for Social Security and Medicare are already on their way to insolvency.” He added, “I’m not a fan.”
With that, here’s my biggest worry: tweaking taxes aren’t always the best answer to economic uncertainty. That’s especially true if the underlying issues won’t be resolved with those changes, or if the tax cuts aren’t targeted to those who need relief the most. Often, as with my dress, even if you have the best of intentions, hacking away at something means that you’re simply left with a bigger mess.
So far, there’s no specific payroll tax cut plan on the table. If (and when) that changes, I’ll let you know.