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Payroll Tax Doubles in this Republican Dream Plan

Author: Amity Shlaes, Former Hayek Senior Fellow for Political Economy
September 7, 2010
Bloomberg

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How to get it back. That's what Republicans are wondering regarding citizens' trust as they bask in the possibility of gaining control of both the House and Senate in the November elections.

After all, winning isn't enough if you want to pass serious legislation. You also need voter good will. To earn that kind of fidelity, Republicans must dream up and deliver a policy that makes voters trust them in the long run. Economics are especially important, because this is where voters have lost the most trust in their government.

Herewith, three modest economic suggestions.

Impossible Idea No. 1: Double the payroll tax.

What?

That's right, double the payroll tax for Social Security to 24.8 percent from its current 12.4 percent.

Right now both parties misrepresent Social Security to the electorate as a non-crisis, a problem to be dealt with later. Therefore, voters don't think overhauling the program is a priority.

Democrats point out that Social Security is only a little bit into the red this year, and that the entitlement's big shortfalls are a decade or more down the road. Their position that there's no crisis reflects remarkable audacity. It's the same line Democrats uttered just a few years ago regarding Fannie Mae and Freddie Mac.

Lacking Credibility

Republicans aren't credible either. Their idea of allowing government to move some of its Social Security funds into the stock and bond markets, and then to manage that money conservatively, sounded possible in the 1990s.

But these days we know, again thanks to hybrids Fannie and Freddie, that the marriage of public and private for the sake of investment returns doesn't always work out. The part that's private doesn't support the public part; it brings it to its knees.

Another GOP idea is to offer a temporary payroll tax holiday for new hires. This sends the inaccurate message that Social Security is in such acceptable shape that we can afford to use it for another purpose: general stimulus.

Doubling the payroll tax acknowledges the more serious reality. This would present Americans with the bracing experience of recognizing the actual extent of the burden they and their children already shoulder. They would ask politicians to do something about Social Security. Suddenly our lawmakers would be competing to see who could grab the so-called third rail first.

Intriguing Option

Of course there are a thousand objections to this idea. The revenue would wash into the government general fund, allowing succeeding administrations to do what's always done: cover up the extent of our budget deficits. This high tax would slow hiring and hurt the incentive to work.

David John of the Heritage Foundation puts forward a more palatable version of the plan. John would stanch the Social Security system's red ink by reducing government pensions that higher earners receive while simultaneously raising the retirement age to 68. The additional taxed money would flow into an individual's retirement savings plan instead of going to the government. Since individuals would manage that second 12.4 percent, the hazard of government corruption would be lessened.

It's gruesome, but not as gruesome as the consequences of another decade of denial for Social Security. Then something close to doubling the payroll tax starts to become mandatory to put the program in long-term balance. Many will complain that the economy is too delicate to withstand such a tax increase. There comes a point when in our continued management of yesterday's crisis -- the one in our financial system -- we ensure another crisis tomorrow. We're at that point.

Reducing Rates

Impossible Idea No. 2: Cut the capital-gains rate and the tax on dividends to 5 percent, permanently.

Procedural rules of Congress say all tax cuts must be paid for elsewhere in the budget, at least on paper. To honor revenue neutrality, as the principle is known, lawmakers would have to make cuts elsewhere. Or, change the rules.

Lowering the capital-gains and dividend tax rates would bring in foreign capital from all over the world -- enough to wipe the phrase revenue neutral out of the national economic vocabulary. Because this tax cut would be applied to capital gains and dividends, it would be far more powerful than allocating the same resources, to, say, yet-larger subsidies to home buyers.

Permanent Cut

Idea No. 3: Make all tax cuts permanent.

There's nothing evil about the one-year tax credit for capital investments that President Barack Obama is proposing. But voters recognize that such a change would merely move up purchases that would otherwise be made later. Voters suspect too that such a cut is designed to anaesthetize opposition to Democrats just long enough to get through November. The temporary nature of this proposal, just as with the President George W. Bush's temporary rebates, fosters voter disillusionment. That makes reform harder.

These solutions reverse the received wisdom, which is that Social Security can never be fiddled with, and the income tax can withstand infinite fiddling. Republicans won't find such ideas easy to consider, let alone execute. Still, to stay in power any party needs policies that earn trust. Right now neither party is offering them.

This article appears in full on CFR.org by permission of its original publisher. It was originally available here.

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