It's truly incredible how quickly our perspective can change in a matter of weeks.
A month ago, coronavirus disease 2019 (COVID-19) appeared serious for those who'd tested positive for the illness but wasn't viewed as a potential disruptor of our lives. Today, however, mitigation efforts in the United States to combat the spread of the coronavirus has touched nearly everyone, whether through cancellations of sporting events, schools, and concerts or panic-buying at local grocery stores.
Shocks to the U.S. economy occur from time to time, and the Federal Reserve and federal government are often called in to "save the day." The Fed handles monetary policy, which includes reducing its fed funds target rate during periods of panic in order to reduce borrowing costs and encourage lending. Meanwhile, the federal government handles fiscal policy and can authorize tax measures that could ultimately put more money into consumers' pockets. Remember, the U.S. generates 70% of its gross domestic product (GDP) from consumption.
With the stock market plunging into bear market territory faster than any previous bear market in history, and mitigation efforts to slow the spread of COVID-19 potentially resulting in extended layoffs for workers and small businesses, the federal government has tinkered with a number of ideas to perk up the economy. Unfortunately, one of the core proposals being offered by President Trump would trade possible short-term gains for serious long-term pain.
Donald Trump's payroll tax holiday proposal in a nutshell
With coronavirus becoming a more serious health and financial disruptor in the U.S., President Trump has voiced his opinion that a payroll tax holiday for the remainder of 2020, beginning in April, would put more money in consumers' pockets and help reinvigorate a suddenly floundering economy. In fact, Trump laid out his thesis in a tweet one week ago:
If you want to get money into the hands of people quickly & efficiently, let them have the full money that they earned, APPROVE A PAYROLL TAX CUT until the end of the year, December 31. Then you are doing something that is really meaningful. Only that will make a big difference!— Donald J. Trump (@realDonaldTrump) March 13, 2020
The payroll tax is a 12.4% tax that's applied to earned income -- that's wages and salaries, but not investment income -- ranging from $0.01 to $137,700, as of 2020. This upper limit (known as the maximum taxable earnings cap) increases annually in step with the National Average Wage Index with one exception -- if no cost-of-living adjustment is passed along to Social Security's beneficiaries.
Since 94% of working Americans earn less than $137,700 a year, they pay into Social Security with every dollar earned. As for the other 6% who earn more than $137,700 in salary and wages, every dollar beyond the maximum taxable earnings cap is exempt from the payroll tax.
Furthermore, most workers are employed by someone else or a corporation, meaning they're not going to be liable for the full 12.4% tax rate on earned income. Though the self-employed are paying the full 12.4% rate, workers are responsible for paying 6.2% of their earned income, with their employer covering the other 6.2%.
According to Trump's proposal of a complete payroll tax holiday for the remaining nine months of 2020, workers would pay this 6.2% or 12.4% rate on earned income through March 31, 2020, then no longer pay this tax for the remainder of the year.
As of the fourth quarter of 2019, median income for a full-time salaried worker extrapolated out to $48,672, or $12,168 per quarter. This would mean the median salaried employee in the U.S. would net $36,504 in earned income for the final nine months of 2020 that would be exempt from the payroll tax, saving them an average of $2,263 if employed by someone else, or $4,526 if self-employed.
For what it's worth, this isn't the first time we've seen a payroll tax holiday put into motion to spur consumer confidence and spending. In 2011 and 2012, following the worst recession for the U.S. since the Great Depression, President Obama instituted a partial payroll tax holiday that reduced a worker's tax liability from 6.2% to 4.2% of their earned income.
A complete payroll tax halt would be devastating to Social Security
Although the payroll tax holiday would be effective in putting more income in consumers' pockets (assuming many aren't stuck on the sidelines for an extended period of time due to coronavirus mitigation efforts), the impact it would have on Social Security's longer-term outlook would be nothing short of devastating.
First of all, the payroll tax is Social Security's workhorse funding source. In 2018, it brought in $885 billion of the $1 trillion collected by the program, with the remainder comprised of interest income ($83 billion) and the taxation of benefits ($35 billion). Completely halting the collection of the program's key revenue source would be a huge gut punch to Social Security.
You see, Social Security was already projected by the Social Security Board of Trustees to expend more than it collects this year. This net-cash outflow, its first since 1982, was estimated to be a reasonably small $4 billion. I know this may not sound like a small number but it's relative to the $2.9 trillion in asset reserves (i.e., net-cash surpluses) the program has built up since its inception. But if the payroll tax holiday were put in effect as of April 1, 2020, my personal estimate is Social Security's net-cash outflow would reach approximately $700 billion in 2020. This would effectively draw down a quarter of the program's asset reserves.
That's a problem, because the annual Trustees report has already forecast a widening net-cash outflow with each passing year beyond 2020. As of right now, Social Security's asset reserves are expected to be completely gone by 2035, assuming lawmakers on Capitol Hill don't make any changes to the Social Security program. But if Trump's payroll tax holiday were implemented, it's a foregone conclusion that the asset-reserve depletion date would come much sooner.
There is something important you should know about the Social Security program -- namely, Social Security can't go bankrupt. Since the payroll tax and taxation of benefits are recurring sources of income, the program will always have revenue generated from these taxes to disburse to eligible beneficiaries. This means that if you're eligible to receive a retired worker benefit in five or 50 years from now, you'll still receive a payout.
However, completely depleting Social Security's asset reserves would concretely signal the need to reduce payouts across the board to keep the program solvent. According to the Trustees, this could mean a reduction in monthly benefits of up to 23% for retired workers.
No matter what happens, Social Security will survive and continue sending benefit checks to retired workers. But if Trump initiates a complete payroll tax holiday, the time frame before benefit cuts become necessary to maintain Social Security's long-term solvency will shrink significantly.