Making Payroll
Oh, and while we’re on the topic of taxes and fiscal responsibility, I notice that John McCain has decided to join Barack Obama at least partway by contemplating a payroll tax increase. Can I say right now that this is a really bad idea?
First of all, Social Security isn’t in nearly as much trouble as all of us thought. It would take only minor tweaks – modestly raising the retirement age, for example – to get the program into good shape. You want to see an entitlement in trouble, go next door and check out Medicare – which, I will note, doesn’t have an earnings cap.
Second, for decades now we’ve been funding the general budget with payroll taxes. But it’s somehow morally wrong to fund Social Security with general federal revenues? Why, exactly? What is the principle here?
Third, Obama’s proposal is to raise the cap on wages that are subject to FICA. That’s probably what McCain is “putting on the table” as well; indeed, the Bush Administration put it on the table when it was trying to get private accounts passed back in early 2005. Do these proposals contemplate increasing benefits to upper-income seniors as well? Presumably not. So, basically, we’re talking about just creating a new tax – on high-wage-earners – to increase revenues. Right? So why, specifically, use the payroll tax? Just because maybe then people won’t notice that Social Security is part of the regular budget? And people who fret about marginal tax rates won’t notice that this is a big tax hike on upper-income earners?
Meanwhile, take any poll of economists and they will tell you: the payroll tax is among the most economically destructive taxes around, specifically because it is a tax on wages. I mean, if we’re trying to soak the rich to pay benefits to seniors, why on earth would we specifically target wage-earners and exempt the idle rich?
We shouldn’t be raising the payroll tax – we should be cutting it, and offsetting the cost of the cuts with spending cuts (means-test benefits?) and/or other tax hikes that will be less economically destructive (cut the mortgage deduction? institute a value-added tax?). Either party could grab this – the payroll tax is a tax on employment, a burden on business that discourages job creation; a regressive tax on hard-working people trying to put food on their families that exempts dividend-clippers and other trust-fund scumbags; an inducement to hire undocumented immigrants who live in the shadows – there are GOP-friendly and Democrat-friendly arguments to cut or eliminate the payroll tax and fund our Social Security obligations in a more economically efficient manner (and then we could have a healthy debate about what that manner might be). There ought to be a bidding war over who will do more for payroll tax relief! Instead, we’re going the other way.
take any poll of economists and they will tell you: the payroll tax is among the most economically destructive taxes around, specifically because it is a tax on wages.
My understanding is that there is a fair bit of dispute about how destructive any increase in taxes on wages is. It’s one thing to say that if there’s an effect, it’s a bad one, and another to make a claim about the size of the effect.
— SomeCallMeTim · Jul 28, 08:24 PM · #
I’m not making a claim about the absolute size, only about the relative size – and I did think there was a pretty fair consensus that taking wages is more economically destructive than taxing income, which in turn is more economically destructive than taxing consumption.
— Noah Millman · Jul 28, 09:14 PM · #
and I did think there was a pretty fair consensus that taking wages is more economically destructive than taxing income, which in turn is more economically destructive than taxing consumption.
Right. But I’m wondering (a) to what extent that’s just driven out by the basic theory (cf. employment rates, minimum wage increases, and whatever the deal was with David Card’s research), and (b) whether, for a given size of destruction, other benefits—like getting away with it politically—might not outweigh any costs.
— SomeCallMeTim · Jul 28, 10:08 PM · #
Oops, Noah. Economists recognize that taxing wages (broadly defined) is economically equivalent to taxing consumption. They also generally agree that taxing income instead of consumption increases the total inefficiency (one adds an inter-temporal distortion without reducing the discouragement of work and market consumption. See, e.g., my article “Beyond the Pro-Consumption Tax Consensus,” from the 2007 Stanford Law Review, available at http://lawreview.stanford.edu/content/issue3/Shaviro.pdf.
To recapitulate what economists know: (a) taxing wages is equivalent to taxing consumption (this of course abstracts from various issues such as applicable legal definitions, transition, etc.) and (b) taxing income is more destructive than taxing wages or consumption.
So I think your post needs a bit of correction.
— Daniel Shaviro · Jul 29, 05:49 PM · #
Daniel: the article you wrote looks very worth reading. Here’s a question I have. Suppose I own a business as well as a trust fund. I pay myself no salary, and live off my trust fund, but I work to build up my business to a much greater value. Eventually I sell the business. I spend the entire sale value on expensive vacations, caviar, dates with supermodels – the value is entirely consumed. If only wages were taxed, I’d never pay a penny in tax. If consumption were taxed, I’d pay taxes on the entire value. Unless when you say “broadly defined” you include some imputation of the appreciation of my capital to “foregone wages” that would then by taxed, in which case your definition of “wages” is too abstract for practical use, I think. But perhaps I misunderstood you.
In any event, thanks for writing.
— Noah Millman · Jul 29, 06:27 PM · #
Unfortunately, Noah, just looking at tax classes doesn’t tell the whole story. The 2 big advantages that the US’s payroll taxes have (over our other taxes) are that 1) they’re dead simple and 2) they raise, to put it scientifically, a metric f*ckton of money. To the first point, simple taxes tend to be less economically harmful because they have far lower compliance costs and lower noncompliance rates.
The second though, is where I have questions: After all, it seems a bit odd that, immediately following a paean to fiscal responsibility, your very next post is an attack on an idea that would help balance the books, and instead suggests cancelling it and replacing it with, to put it kindly, a bunch of hand-waving. Keep in mind our current deficit is already almost $500 billion, and payroll taxes bring in $850 billion a year; without that, we’re starting from a baseline deficit of $1.3 trillion dollars. Meanwhile, the mortgage interest deduction costs the US government in the neighborhood of $70 billion a year and expecting a national sales tax to get enacted on top of our current income tax is just pipe dreaming. I just don’t see how you can even imagine your numbers add up here.
It would be nice if, among the paeans to fiscal responsibility, you would deign to provide an actual idea on how to get from here to there. Or at the very least stop pushing in the other direction.
— Bo · Jul 29, 08:44 PM · #
Bo: why is it a pipe dream to talk about replacing the payroll tax with a value-added tax? Every major industrial country but the USA has a value-added tax. It’s dead easy to administer and is among the more economically efficient taxes. Most people would say it’s regressive (including me – I don’t buy the argument that there’s no “value” to owning wealth until it’s consumed, and therefore a VAT is progressive since it only taxes consumption), but so is FICA (since it’s capped, and ignores income from rents, dividends, licenses, etc). What makes it a pipe-dream?
And it could certainly bring in enough income at realistic levels. Payroll taxes (Social Security + Medicare, both employer and employee contributions) total 15.3%. A VAT set at 15.3% would probably bring in about $800mm. Throw in $70mm from closing the mortgage deduction and you’re flat to positive. The numbers work out. The UK imposes a VAT of 17.5% except on certain essentials (food, books, wheelchairs, home heating).
The oft-cited reason people don’t want to mess with FICA is that people think Social Security will lose popular support if there isn’t some kind of tie between pay-in based on wages and benefits based on wages. Fund SSA out of GFR and (they argue) you could more plausibly index benefits to inflation rather than wage growth, or what-have-you.
My response is twofold:
(1) We’re currently funding the rest of the government with the Social Security surplus; why isn’t that just as wrong, if not more so? If Social Security’s integrity depends on it being completely separate from the rest of the budget, then we should immediately cut the payroll tax and eliminate the surplus. Daniel Patrick Moynihan proposed just this a couple of years before he died, I believe.
(2) The AARP is not such a pushover that the government could enact massive across-the-board cuts without a fatal political consequence, and that won’t change if the revenue mechanism changes.
— Noah Millman · Jul 29, 09:34 PM · #
I think you’re missing the main problems here, Noah.
1) The fact that other countries do it has nothing to do with whether it’s possible here. Exhibit A: universal health care. Exhibit B: national sales tax. Any politician promoting a completely new national sales tax is going to get crucified by everyone from the AARP to the CFG.
2) Despite your hang-up on trust-fund scumbags, the vast majority of people living off savings (and rents, licenses, capital gains, etc.) are actually retirees. If you think the AARP will save SS but fail to kill a VAT, you’re dreaming.
3) Whether SS is running a surplus or a deficit compared to the rest of the budget is a charade I’ve long given up caring about. The budget itself is running a deficit; from a fiscal responsibility standpoint, that’s the important fact.
4) A 15% VAT wouldn’t raise enough to replace even the current payroll tax. For comparison, the UK’s 17.5% VAT raises approximately 5% of GDP in taxes, which would translate to ~$650 billion if transplanted here. Your percentage, you’ll notice, is lower than the UK’s.
5) The actual number a VAT would need to raise to balance the budget (which I’ll note, doesn’t even touch our current debt) is $1.3 trillion, which would translate to a VAT rate of more like 30%. Consumption taxes that high tend to promote black markets and barter, i.e. less efficient markets.
6) The payroll tax is even simpler to administer than a VAT, and, moreso, it has stayed simple for 70 years now, while our income tax has been hacked and exceptioned a million different ways. The tinkerability of the VAT is just asking for the same complexity problems we have with the income tax.
7) The change that both Obama and McCain are proposing is to raise the cap, not the rate. You can’t have it both ways, treating the cap as a strike against our payroll tax, while arguing against its removal as a tax hike. Obviously, if you removed the cap, you could lower the rate and still keep it revenue-neutral; it’s too bad we don’t have the luxury of revenue neutrality any more.
So, to wrap up, the VAT is a tax that will never pass and that wouldn’t replace even our current payroll taxes if it did, never mind any of our half-trillion dollar deficit. Our payroll taxes are simple and raise a ton of money, but are highly regressive due to their cap. Oh, and we have a huge deficit that it would be a good idea to do something about, right? It’s really disappointing how you’re engaging in blatant tax demagoguery at the expense of our nation’s finances in the post exactly after the one where you criticize others’ fiscal irresponsibility.
— Bo · Jul 29, 10:44 PM · #
Bo:
(1) OK, you and I have a different sense of what’s politically plausible – or, perhaps, a different sense of the role of an unaffiliated commentator like myself. Should liberal commentators never argue for national health insurance because it’s politically “impossible” to pass in America?
(2) “Trust-fund scumbags” is more of a Matt Yglesias shout-out than anything else, not an obsession of mine. And yes, I’m aware that retirees are spending down their assets while working-age people are accumulating them. So yes, I’m also aware that a VAT replacing FICA would be a back-door way of taxing benefits. It sounds like you’re taking the perspective that there is no possibility of revisiting the equity of the current inter-generational transfer. OK, but I don’t take that view.
(3) OK, so you’d have no problem raising the payroll tax rate to close the budget gap? Of course you would. You care about things other than keeping the budget in balance – for example, equity between economic classes. I care about that, too. Also about equity between the generations. Also about efficiency. Also about economic growth. The fact that since the Reagan Administration we have been using the payroll tax to fund the rest of the government should bother progressives more than anybody, I should think.
(4) OK, so your numbers differ from mine by $200bn. Both of us are doing quick back-of-the-envelope calculations, so either of us could be wrong. I’ll certainly agree with you that a VAT above the high teens would start to be really problematic in terms of encouraging a black market, and I’m not proposing that. If my numbers are wrong, and you can’t replace the payroll tax with a VAT in a revenue-neutral way at reasonable rates, then I’d have to do some tinkering.
(5) Right: we can’t close the budget gap and replace FICA by implementing a VAT. I didn’t propose doing so. Who are you arguing with?
(6) If I was aiming to maximize efficiency, I’d propose replacing the income tax with a VAT. Certainly, there’s a good argument to be made for replacing the corporate income tax (an especially inefficient tax) with a VAT (and, of course, you’d need to raise dividend and capital gains taxes to the level of ordinary income taxes so that returns to capital are still taxed). But the income tax is, whatever else, a progressive tax, and I’m reluctant to propose eliminating an inefficient tax that is also the main prop of progressivity in the system (and no, I don’t buy the argument that consumption taxes are “actually” more progressive, because they more comprehensively tax the lifetime earnings of the wealthy). In any event, I’m going to throw your “can’t have it both ways” back at you: if what you like about the payroll tax is that it hasn’t been tinkered with, why are you supporting tinkering with it (by creating a new tax rate above the current cap)?
(7) If my only beef with payroll taxes was that they are capped, then it would be crazy for me to object to raising or eliminating the cap. But I have made other objections – as noted: that, as a tax on labor, it’s particularly destructive. Obama has proposed raising the top tax bracket back to Clinton’s level and adding a new tax on wages above the cap. I think the former is more honest than the latter, inasmuch as it makes it clear what’s being proposed in terms of changes to marginal rates and inasmuch as the income tax is intended to fund the operations of the government generally, and more reasonable, inasmuch as it captures a broader spectrum of income. If either candidate were proposing raising the cap, lowering the rate, and making changes on the benefits side that made the benefits equation more progressive (and less expensive), I could see the logic of that mix of proposals. But that’s not what I’ve heard them proposing.
(8) You accuse me of “blatant tax demagoguery at the expense of our nation’s finances.” I’m dying to know what, in my original post or our exchange, I wrote to deserve that accusation, why you consider it impossible for me to be honest but wrong.
— Noah Millman · Jul 30, 01:22 PM · #
I’ll admit that the ‘trust-fund scumbag’ was a bit tongue-in-cheek. It did seem that by focusing on a hypothetical member of the idle rich, you were trying to misdirect us from the real economic and political problem with implementing a VAT. Namely that it’d actually end up involving a hypothetical Grandma Susie, who, hypothetically, raised five kids the right way, having to switch from chunk light tuna to dog food thanks to her savings being decimated by a VAT.
But whatever, feel free to ‘revisit the equity of the current inter-generational transfer’ (yawn) all you want. As my Grandma Susie used to say, you don’t buy a Ferrari because you deserve to be a movie star. We have a huge deficit today, largely because of the tax cuts and military adventurism you explicitly cheered on, and it’s more than a bit ridiculous to attack the best political possibility of rectifying that today, along with fixing a major economic problem with our current payroll tax, in favor of some obvious pie-in-the-sky. If that’s merely accidental demagoguery, then I apologize.
In the end, fiscal responsibility actually does involve making tough choices. Sure, as a unaffiliated (cough) commenter, you can talk about scrapping whole sections of our tax code with entirely unlikely replacements, and shrug at adding 100 or 200 billion to our huge deficit, all while claiming fiscal responsibility is very important. However, you should also understand that neither McCain nor Obama will be in that enviable position should they become president.
— Bo · Jul 30, 03:50 PM · #