Don’t allow another payroll tax accounting gimmick

Charles Blahous Contributor
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During his Monday evening address to the nation on the budget negotiations, President Obama repeated his call for an extension of the current one-year Social Security payroll tax cut. Whether or not this extension is agreed to as part of a larger budget deal, it is vital that Congress not permit a repeat of a costly accounting gimmick implemented when the temporary tax cut was enacted last year. The gimmick results in real additional costs and additional debt, and undermines the accounting integrity of the Social Security trust funds.

Last December, Congress temporarily cut the employee share of the Social Security payroll tax rate from 6.2 percent to 4.2 percent. Tucked away in the legislation, however, was text mandating that the government continue to credit the trust funds as though that payroll tax rate were still 6.2 percent. The practical effect of this accounting gimmick is the issuance of roughly $105 billion in additional debt to the Social Security trust funds in 2011. This added debt will earn interest over time resulting in the obligation of hundreds of billions of dollars in future benefit payments — benefits that no one has yet actually paid for. There are several reasons why this accounting gimmick is damaging, costly and should not be repeated if Congress agrees to extend the current payroll tax cut:

1) It’s unnecessary and irrelevant to any stimulus purpose. The argument for the payroll tax cut is that it provides near-term stimulus. But the accompanying general revenue transfer has absolutely nothing to do with stimulus. Its effect is only to avoid recognizing what would otherwise be transparent: that cutting the Social Security payroll tax affects the program’s trust funds as well as the government’s larger ability to finance Social Security benefits.

2) It contradicts the ostensible purpose of ongoing budget/debt negotiations. It’s one thing to support a payroll tax cut, even though to a first approximation this increases deficits and borrowing from the public. But the accompanying general revenue transfer embodies a second round of debt issuance to the Social Security trust funds, resulting in a double dose of gross debt subject to the debt ceiling. It can only worsen public cynicism if policy makers engage in accounting gimmicks that balloon the very debt they are supposedly trying to constrain.

3) It costs real money. Additional debt issued to the trust funds unquestionably results in real additional spending. This is true on its face, as the program’s authority to finance benefits is defined by the amount of assets in its trust funds. But it is also a phenomenon caused in part by political economy realities. Currently Social Security is bringing in roughly $151 billion less in taxes than it is paying out in benefits, yet there are virtually no calls to cut benefit payments to today’s seniors by anything resembling that amount. Why? Because of the positive balance in Social Security’s trust funds. For both technical and political economy reasons, the issuance of over $100 billion in annual additional trust fund debt, and the accumulation of interest on that debt, will eventually result in hundreds of billions of dollars in further spending.

4) It shifts Social Security’s financing basis from payroll taxes paid by today’s workers to higher income tax burdens on our children. When we issue general-revenue-financed debt to the trust funds, we increase the program’s authority to pay benefits without increasing the government’s actual ability to pay. Such increased debt owed by the general funds will be paid largely from future income taxes, a fundamental policy shift that should be publicly debated and transparently decided rather than accomplished by under-the-radar accounting changes.

5) It belies the public representation that the Social Security trust funds consist of payroll taxes paid by workers toward their eventual benefits. The standard view of the trust funds’ bonds as having been “purchased with worker contributions” is increasingly belied by federal policy. In fact, the $105 billion in general revenue transfers to the trust funds this year is greater than the amount of surplus payroll taxes paid by workers in any previous year.

Whether the current payroll tax cut should be continued beyond 2011 is a matter warranting serious debate. But cutting the payroll tax has inevitable implications for Social Security financing, implications that government accounting should transparently acknowledge. In any event, under no circumstances should we repeat the accounting gimmick employed last time around.

(This is a condensed version of an article that was published in E21.)

Charles Blahous is a research fellow with the Hoover Institution and serves as one of the two public trustees for the Social Security and Medicare programs. He is also the author of Social Security: The Unfinished Work.