Trump's proposed payroll tax holiday could hurt the economy more than it helps

A payroll tax cut proposed by President Donald Trump to help combat the economic effects of the COVID-19 outbreak would mean bigger paychecks for workers, but it could come with big consequences later.

Temporary elimination of Social Security and Medicare taxes would mean that workers would see as much as 7.65% more money in their take-home pay, but halting payments into those entitlement systems would further threaten their solvency and could increase the U.S.'s debt considerably, numerous sources interviewed for this story said.

Further, the strategy would only affect people who are currently employed – those without jobs or are in hourly positions and unable to work would see no benefit.

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The tax holiday could cost as much as $840 billion, depending on the size and duration of the temporary suspension, said Marc Goldwein, head of policy at the Committee for a Responsible Federal Budget.

“There are risks on the back end,” Mr. Goldwein said. If the government did a full suspension of all payments into entitlement programs, “bringing it back is going to feel like a 12% tax increase," he said, adding that it "could be a big shock.”

When the loosely proposed tax holiday expires, that would bring household income back down and could have an emotional impact on workers, he said. It also would almost certainly have macro-economic consequences, he said.

NOT A PRECEDENT

It would not be the first time the federal government has instituted a payroll tax suspension. Under the Obama administration, Congress passed one in 2010, cutting two percentage points from the rate workers paid for Social Security in 2011 and 2012, reducing it during that period to 4.2% from 6.2%.

The costs to Social Security were reimbursed from the General Fund, but a larger payroll tax holiday, today, would likely need to be paid back by borrowing, Mr. Goldwein said. Or, the Social Security system would simply take a hit and would have to be adjusted to reduce payments to retirees.

“It’s possible this time would be different,” Mr. Goldwein said. “[Now, at] 15 years from the insolvency date, if we did a bigger tax holiday, it could make it harder to unwind.”

President Trump similarly proposed a payroll tax suspension last year for 2020. Had that gone into effect, a two-percentage-point reduction in Social Security taxes would have cost between $141 million and $151 million over 10 years, according to a report from researchers at the University of Pennsylvania’s Wharton School. It would have boosted gross domestic product by about 0.3% for 2020, “with effects eventually turning slightly negative over time with higher deficits.”

Because the proposed payroll tax holiday would not help people who have no take-home pay, “We really have to ask: Is this the most effective way to help people right now?” said Jeffrey Levine, director of advanced planning at Buckingham Wealth Partners. “Having a lower tax rate on income you don’t have doesn’t matter.”

Further, the option of replenishing Social Security and Medicare through loans is a shaky proposition in the current global economy, he said.

“Our trade borrowing partners like China might not have the same ability to finance us as they once did,” he said.

SOCIAL SECURITY AT RISK

Though the proposed payroll tax suspension would boost take-home pay this year, it could have the effect of reducing Social Security payments for people when they retire, said Danielle Seurkamp, founder of Well Spent Wealth Planning, in an email.

“Social Security benefits are based on your highest-earning 35 years of work history, but the benefits calculation is based on how much tax you paid in, not the actual amount of your income,” Ms. Seurkamp said.

For millennial workers, the long-term effects “would be largely negative,” said Shaun Melby, who runs Melby Wealth Management.

“For my younger clients, I’m already factoring in a reduced social security benefit when they are retired as that is one of the more practical and realistic ‘fixes’ I foresee being on the table,” Mr. Melby said in an email. “If this were enacted, it would only solidify my stance.”

But because of the 35-year calculation for highest earnings, the effect of a payroll tax holiday on Social Security payments down the road could be minimal for many people, said Andy Panko, owner of Tenon Financial, in an email.

“I don’t know how much a payroll tax cut will help minimize the economic impacts of the coronavirus,” Mr. Panko wrote. “Having a little more take-home pay won’t incentive people to take cruises, go on planes, end factory closures in other countries, etc.”