Commentary: Cutting payroll tax could find bipartisan support

By Eugene Ludwig / Special to The Washington Post

President Trump has promised to introduce a new tax-cut plan before the November election, but whatever he and congressional Republicans come up with is likely to be dismissed as little more than political theater.

Why, after all, would Speaker Nancy Pelosi let any White House-drafted tax bill pass through the Democratic-controlled House ahead of the critical 2020 vote? But one possible part of the plan, which has been under discussion at least since last summer, should have broad bipartisan appeal: cutting the payroll tax, an idea Trump reintroduced Monday in a tweet. “The Democrats in the House should propose a very simple one year Payroll Tax cut,” he wrote. “Great for the middle class, great for the USA!”

Few federal policies are as deeply regressive as this tax. If what most voters thirst for from Congress is positive action on their behalf, here is an opportunity for the two parties to make progress together.

The payroll levy, established as part of the Social Security Act of 1935, has been a source of controversy for nearly a century. It was designed to cover the costs of America’s most important public retirement-security program by skimming a bit off the top of each salaried worker’s earnings and requiring employers to match that contribution. Through the bulk of the industrial boom in the United States, the system worked well, requiring just a few adjustments through the years. But today, with the nation’s evolution away from old-style factory jobs and toward the gig economy, financing Social Security with a payroll levy no longer works.

At a moment when Democrats are rightfully preoccupied with the scourge of inequality, and Republicans remain focused on cutting taxes, replacing the payroll levy would serve both progressive and conservative interests.

During the 1930s, at the zenith of the New Deal, President Franklin Roosevelt asked Labor Secretary Frances Perkins to design a plan to protect older Americans from financial insecurity. Washington had never considered a long-term economic intervention on the scale of what would become Social Security, and Perkins and Roosevelt found themselves buffeted between two ideologically opposed camps. On the right were conservatives averse to any expanded government role. At the other extreme, populists, led by Sen. Huey Long, D-La., had begun a movement to guarantee every family an annual income of $2,000. (Today’s political arguments, clearly, are not new.)

After fierce debates, Roosevelt and Perkins settled on an approach designed to allay some of the most pointed criticism from both sides. In a nod to more conservative skeptics, they designed Social Security to reflect the contours of European models; eschewing populists’ demands for a universal basic income, they crafted a “social insurance” program in which citizens would pay a premium of sorts and later receive a stipend. The plan would not soak the rich or implement a national sales tax, instead imposing a new payroll tax split between employers and employees.

This system worked remarkably well. In an era when income inequality was not nearly so pronounced, few eligible enrollees had income above the taxable threshold of $3,000, meaning few earned dollars were exempt from the levy. Maybe more important, almost every covered worker had an employer with whom they split the cost; though too many weren’t covered, like agricultural and domestic workers, many of whom were African American. Finally, because the financial burden and budgetary impact of payroll taxation was minimal, providing roughly 1 percent of federal revenue in the initial years, few had real cause to object.

Since then, however, circumstances have changed; drastically. Now the payroll tax isn’t a small addendum to the federal budget: As Social Security has evolved, it has grown to encompass 35 percent of federal revenue. Moreover, in 2019, 68 percent of taxpayers were projected to pay more in payroll taxes than in income taxes. Maybe equally important, as an increasing share of the workforce enters the gig economy, fewer workers have an employer with whom to split the cost. General Motors today covers 50 percent of the payroll tax assessed to an employee working on an assembly line, but an Uber or Lyft driver, considered a “contractor” rather than an “employee,” must cover the whole nut. In other words, not only does the payroll tax worsen inequality, it discourages economic activity by inflating hiring costs and depressing job growth.

Viewed in that context, you can see why this particular flavor of tax reform could draw bipartisan support. In calling for a payroll tax cut (before retreating from the idea and then later suggesting it might still be on the table), Trump was echoing work by the Urban-Brookings Tax Policy Center, which wrote that the payroll tax is the most significant federal tax borne by the lowest-income Americans, as far as how much they pay.

None of that is to suggest that critics of a payroll tax cut don’t have legitimate concerns. Some worry, for example, that changes would threaten Social Security. But that would be true only if Congress did not provide an alternative source of revenue. Others object that lowering the payroll tax would increase the deficit, a particular concern given that the annual deficit has inched toward $1 trillion. But here, too, there could be a shared solution. Fiscal hawks in both parties should insist that payroll tax cuts be offset by something that doesn’t penalize labor; perhaps a levy on consumption, luxury goods, carbon, high incomes or some combination.

Some also worry that cutting the payroll tax would shift the burden from high-income families to those earning much more modest salaries. But let’s be clear about the incumbent regime. Because a large portion of the levy does not apply to income over $137,700, someone with $1 million in taxable earnings pays a much smaller share of their income than someone making $85,000. In 2019, a family with taxable income of $30,000 to $40,000 was projected to pay an average of 8.8 percent to the IRS in payroll taxes, while a family with $1 million or more in taxable income would fork over a mere 1.9 percent, on average. Sure, we need to be careful about how we fill the revenue gap that a cut would create, but let’s not pretend the status quo is worth defending.

Obviously, the looming election tinges the payroll tax debate with political concerns. But the changing realities of the American economy have scrambled the politics. Democrats and Republicans both have reason to believe that what was a good idea in the 1930s has more recently become a policy disaster. Rarely do our nation’s leaders find themselves presented with an opportunity to free middle- and working-class families from a burden they’ve been forced to shoulder disproportionately for much too long. Oddly enough, the run-up to the election may provide a rare window where good policy and good politics align.

Eugene Ludwig is the founder and CEO of Promontory Financial Group, a global risk management and regulatory compliance consulting firm. From 1993 to 1998, he served as President Bill Clinton’s comptroller of the currency.