Strategic Communications and Marketing News Bureau

Would cutting payroll taxes help prevent recession?

Editor’s note: President Trump recently has floated – and then rejected – a number of ideas to jumpstart a stalling economy. Richard L. Kaplan, the Guy Raymond Jones Chair in Law at Illinois, is an internationally recognized expert on U.S. tax policy. In an interview with News Bureau business and law editor Phil Ciciora, he discusses the implications of cutting the payroll tax.

Is the idea of cutting payroll taxes sound policy or more of a last-gasp attempt to stave off a recession?

Politicians always want to be seen as doing something, and cutting the payroll tax could represent the middle-class tax cut that the president campaigned on and then largely forgot about in 2017.

But to the extent that the president thinks this is necessary to stimulate the economy and prevent the U.S. from tipping over into a recession, the bigger question is, why wasn’t this included in the Tax Cuts and Jobs Act of 2017? This proposal is a tacit admission that the 2017 version of tax reform didn’t do much for working people. In any case, it doesn’t look like Congress would enact anything the president proposes.

When would any potential changes show up?

No time soon. Unlike tariffs, a president cannot unilaterally cut payroll taxes through executive action. Instead, he must work through the legislative process and if tax legislation is being considered, the new majority in the House of Representatives may want to revisit the 2017 Tax Act, so getting something done may take a while. As a result, any impact on affected taxpayers would probably not show until after the November 2020 presidential election.

Nevertheless, the payroll tax, otherwise known as the Federal Insurance Contributions Act, affects almost all working Americans. In fact, nearly three-quarters of working Americans pay more in payroll taxes than they pay in federal income taxes. That’s because the payroll tax begins with the first dollar of earnings, unlike the income tax, which has a significant standard deduction. Even part-time workers pay FICA, which goes to fund Social Security and Medicare.

On the other hand, no one is talking about removing the entire 6.2% payroll tax. What happened in the past is the tax was reduced by 2 percentage points, from 6.2% to 4.2%. That reduction still can be significant to lower-income workers, but the boost to their take-home pay is then spread out over the whole year’s paychecks.

Who would benefit from such a pay cut?

A payroll tax tends to benefit lower- and middle-income workers most directly. For higher earners, the payroll tax for Social Security stops at wages above $132,900, but there is no cap for Medicare. So, would Congress lower the payroll tax only on the first $132,900?

A related issue is the impact on the trust funds for Social Security and Medicare, which derive most of their revenue from the payroll tax. Cutting this tax, therefore, makes the financial condition of those trust funds more precarious.

When the payroll tax was last cut in 2010 under the Obama administration, Congress directed that the lost tax revenue was restored to the Social Security and Medicare trust funds by using general income tax revenues. If this proposed payroll tax is handled similarly, the effect would be still larger budget deficits.

Editor’s note:  To contact Richard L. Kaplan, call 217-333-2499; email rkaplan@illinois.edu.

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