The conflict of employment and payroll taxes

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1 The conflict of employment and payroll taxes Human input in the process of providing goods or services is in a class by itself. In fact, it might actually be the only real factor of production It is thus extremely difficult, from a rational point of view, to understand the political willingness to use a fiscal instrument, such as the payroll tax, unless the aim is to limit the use of this resource. The Public Law of March 18, Hiring Incentives to Restore Employment Act and the closely following P.L of Dec.17, Unemployment Insurance Reauthorization and Job Creation Act are trying to temporarily soften the impacts of this tax. These two laws have put the political and economic focus on the issue of taxing the use of human resources particularly when there is widespread unemployment in the economy. There is obviously a political understanding in the US Congress of the economic impact of the payroll taxes, but an unwillingness to do something rational about it. The payroll taxes pay for the Old-Age and Survivors Insurance (OASI) (our social security retirement insurance) and the Disability Insurance (DI). Additionally, Medicare is financed by a portion of the payroll taxes, but also in part by monthly premiums deducted from retirees' Social Security checks. The funds aggregated from the net portion of these payments end up in the Social Security Trust Funds (SSTF) which are managed by the Department of the Treasury. Since the beginning of the Social Security program all securities held by the trust funds have been issued by the Federal Government, which actually pays interests on these funds. In this context it might be interesting to take a look at the uses and the status of the funds generated by the payroll taxes. Exhibit 1 - US OASI & DI Receipts and Expenditures Nominal US dollar (billions) Receipts Expenditures

2 In Exhibit 1 the receipts and expenditures for the fiscal years (FY) 1977 to 2011 are shown. The receipts culminated in 2009 at around $807 billion 1. As the effects of the recession took hold the receipts dipped to $788 billion in 2010 and increase slightly in 2011 to $799 billion. On the expenditure side (or in Social Security Administration's (SSA) terms the "outgo side"), however, there has only been increases. In 2009 the outgo was $670 billion and in 2011 the SSA paid out $731 billion - an annual average increase for these years of 4.5%. During none of the years included in Exhibit 1 did the expenditures decrease. In fact, the annual average increase in outgo over these years was 6.5%. As the exhibit shows the increases in expenditures have been more or less steady over these years. The recession years have, of course, resulted in decreases in receipts. This is having a significant impact on the Social Security Trust Fund 2 as shown in Exhibit 2. Exhibit 2 - US OASI & DI Assets and Changes Additions to Funds - US Dollars (Billions) Assets - US Dollars (Billions) Increases in funds Accumulated Assets In Exhibit 2 it is clear that in recent years the additions to the Social Security Trust Fund decreased significantly and that the asset growth is tapering off. In the period from 1977 to 1982 the SSTF actually decreased and hit the bottom in 1982 with only $19.3 billion left in its coffers as outgoes were larger than incomes during these years. The fix was of course done through rate increases, i.e., both the rates and the upper base. In 1977 the upper base was $16,000 and the total rate 7.9% shared 50/50 between employers and employees - the FICA structure. In 2011 the base was $106,800 and the rate was 15.3%

3 which now includes a 2.9% for Hospital Insurance 3. In 2012 the base is set to increase to $110,000. Those of us who are fortunate enough to be self-employed have always paid the full rate - the SECA 4 structure. It might be of interest to take a closer look at how the numbers behind the two exhibits come about. In Table 1 the accounts for FY 2010 are tabulated. The total payroll contribution was some $646.6 billion 5. The beneficiaries of a social security paycheck may have to pay taxes on the monies received. "This usually happens only if you have other substantial income (such as wages, self-employment, interest, dividends and other taxable income that must be reported on your tax return) in addition to your benefits."( For example an individual with a combined income (social security and other income) between $25,000 and $34,000, may have to pay income tax on up to 50 percent of his/her benefits. If combined income is more than $34,000, up to 85 percent of the benefits may be taxable. Table 1 - Social Security Trust Fund Evaluation for FY 2010 (in millions) Furthe rmore, the SSTF earns interests on assets parked at the US Department of the Treasury. For FY 2011 this totaled $118.5 billion. Other income 6 which in FY 2010 was minimal is quite substantial in 2011, basically due to transfers from the US Treasury under the Unemployment Insurance Reauthorization and Job Creation Act. Whereas the OASI generated some $102 billion, the Disability Insurance (DI) had a $20 billion deficit. Payroll taxes paid by employers and employees in the US railroad industry, are transferred to the US Railroad Retirement Board for distribution to its retirees. All in all, however, the SSTF increased by $81.7 billion during FY 2010.

4 Table 2 - Social Security Trust Fund Evaluation for FY 2011 (in millions) The picture in Table 2 is somewhat more dismal compared to The total payroll contributions, which includes the Public Law , decreased by some $66 billion. The most striking difference, however, can be found in "Other Income". The increase of about $102 billion comes mainly from contribution by the US Treasury due to P.L , i.e., the Treasury is paying the SSTF for the payroll tax holidays. Furthermore, whereas the total outgo in 2010 was $706 billion, this income statement item reached $731 billion in 2011 an increase of $25 billion. Despite the transfers from the US Treasury compensations authorized by PL and PL , the increase in the SSTF for this year was only $68 billion the lowest since The SSTF belongs to the current and future insurance premium payers and not to the Federal Government. The SSA are just the stewards of the aggregated funds. Social security and disability insurance payments are genuine rights and not political entitlements as they are paid for by US taxpayers through the payroll taxes both FICA & SECA. Additionally, a portion of the payroll taxes has also been going to the Medicare Hospital Insurance Fund since These are all dedicated funds that cannot be raided or defaulted on by the US Treasury which has issued all the IOU's to these two funds. The conflict Taxing the participants in the US economy is a necessity, but seen from an employers' point of view putting surcharges on the use of an underutilized resource is both irrational and counterproductive. The most troubling is the tax ruled by FICA. It is frequently argued that these charges are insurance premiums. They are nevertheless taxes. No taxpayer can opt out. Hence, the government is saying to the people who create jobs and hire people that if you rely on other people to work for you we will punish you with an

5 extra tax. The message from the Federal Government is quite clear: Do not hire people! If you do we will punish you with a payroll tax. The political answer to criticism of the payroll tax goes along the following line: the burden has to be shared equally between the employer and the employee. The net effects on the two taxed entities are completely different. Most of the effect on the employees is a reduction in consumption and a minute reduction in savings. For the employer the effect is most likely a reduction in investments in new facilities to expand the firm and consequently, a decrease in the firm's hiring growth. The political question should really be: which of these effects do you really want in the economy? The people hurt the most by this irrational tax are the small business owners. According to the US SBA the small businesses 1) create more than 50 percent of the nonfarm private gross domestic product (GDP); 2) employ about 50 percent of all private sector workers, and; 3) the 22.9 million small businesses in the United States can be found in virtually every US neighborhood. Putting tax obstacles; and recently the threat of additional charges in the business decisions of this group of Americans, you don't need much imagination to understand the consequences. Federal Insurance Contributions Act (FICA) should have been abolished a long time ago, but since that has not yet happened, now is a good time to get rid of this irrationality in our fiscal policies. Amend the Self Employment Contributions Act (SECA) to include all income earners. Such an amendment should of course include the option of letting employers pay a part or all of the amended SECA contributions if they so wish. This will be a better employment management tool than what they are dealing with today. The Keynesian multiplier effect of the payroll holidays, which was the vain hope behind the legislative actions mentioned above, has so far failed to materialize. If our government needs to discourage economic investments in this society, it should be done with monetary policies rather than with fiscal policies of the FICA type. End Notes 1 The dollar figures are nominal, i.e., not deflated. 2 All data used in this article can be found at 3 Medicare Hospital Insurance Trust Fund 4 FICA stands for "Federal Insurance Contributions Act" and covers taxes on wages; SECA stands for "Self Employment Contributions Act" and covers taxes on selfemployment income

6 5 Payroll tax contributions include transfers from the General Fund of the Treasury for payroll tax revenue forgone under the provisions of Public Law Other income includes reimbursements from the General Fund of the Treasury and a small amount of gifts to the trust funds 7 See endnote 5. 8 See endnote 6.