Tuesday, May 10, 2005


Fix Social Security: Eliminate the payroll tax

One solution to funding Social Security that has not been suggested is to eliminate the payroll tax completely. This is a regressive tax and only captures money from wage income. A large number of low wage workers pay more in payroll taxes than in income tax. Many pay no income tax at all, but still pay payroll tax. Eliminating it would help those at the bottom of the economic ladder the most.

Here's how to do this and fix Social Security at the same time:
It must be remembered that the payroll tax is paid equally by both the employee and the employer, so if we drop it we need to replace it with two income streams. I propose eliminating the payroll tax as a separate tax item and replacing it with an adjustment to the income tax rates. If we take the payroll tax rate as currently in the 8 to 9% range than adding about this amount to the tax rates will generate a similar amount of funds from workers. Thus the 10% tax bracket would become 18% and so on. If desired the increases don't have to be strictly linear, but could be scaled so the income tax brackets become more progressive as in the past. Thus the lowest rate might increase 5% and the highest might be 12% or so.

This also has the effect of eliminating the cap on the payroll tax which is currently a popular suggestion. Careful selection of the new tax rates and brackets can eliminate the Social Security "shortfall".

Doing this would have the effect of improving the standard of living of the poorest workers and would cut down on the need for other compensating public programs such as the earned income tax credit and food stamps. By careful adjustment of the rates and eligibility levels the poorest workers would come out ahead and the total government payments would remain about the same or, perhaps even drop slightly.

We still need to address the loss of income from the elimination of the employee contribution to Social Security. This revenue loss has to be covered as well. As I suggest in my essay on corporate taxes this collection system needs to be overhauled as well.

By substituting a transaction based tax on business the lost revenue can be recaptured. Spending on payroll is just another business expense and would be subject to the same sort of taxation as any other business purchases. By covering all business expenses a transaction tax would also capture revenue from employee expenses which are currently escaping direct taxation such as stock options, personal perquisites like private jets and company paid club memberships, etc. Thus the overall business would be taxed rather than just specific activities. This will also help to reduce planning distortions since a dollar spent on salaries will have the same tax consequences as a dollar spent on contracting out a service.

So for this plan to be fiscally sound it needs a change in the way personal and business income taxes are collected. Who would benefit and who would lose out? The richest workers will see their taxes increase. Depending on their present income and the balance between wages and other forms of compensation their marginal rate might increase as much as 10% or so. This would still be much less than in prior periods of our history when the rate reached into the 70-90% range. It's seems only fair that those who enjoy the largest benefits from our society be prepared to pay the most. Other potential losers are those companies which have arranged their business so as to underpay taxes compared to their peers. Moving nominal operations offshore, for example, would be less favorable since buying from a foreign subsidiary at an inflated price so as to shift the profit to an offshore entity would no longer work. The transaction tax would be based upon the amount paid. We see variations of this type of taxation in the VAT (value added tax) used in Europe and Canada.

The gainers would be low wage earners who would see their taxes decrease. In addition those companies that play by the rules and pay their taxes would be at a more competitive position than presently since their competitors would no longer be able to game the tax system. This would decrease the unfair advantage given to those companies from escaping taxes.

In order to achieve these bold steps we need to get away from the current misleading rhetoric about the "Social Security Trust Fund" and look at the bottom line. It's up to us.

Comments: Post a Comment

<< Home

This page is powered by Blogger. Isn't yours?