Trump's radical plan to waive payroll tax would punch hole in Social Security, Medicare budgets

By Howard Schneider and Steve Holland

WASHINGTON (Reuters) - President Donald Trump has picked his favorite weapon to fight the economic fallout from the coronavirus - an elimination of the "payroll tax" on workers' gross earnings that is used to fund national retirement programs.

Trump advisers on the White House economic team and Republican lawmakers are pushing for more targeted stimulus. But Trump has held firm on the idea, White House and Republican sources say.

Trump told Republican senators in a meeting Tuesday he would like to waive the payroll tax entirely through the end of the year, or even permanently suspend it, one attendee told Reuters.

If approved by Congress, the move would result in a massive, roughly $1 trillion dollar cash injection into the pockets of workers and businesses over the rest of the year, based on a Congressional Budget Office estimate https://www.cbo.gov/topics/taxes of current projected federal tax revenue.

It would also mean "you've blown a trillion dollar hole" in the trust funds that pay Social Security benefits for retirees and help fund the Medicare health care program for Americans over age 65, said Howard Gleckman, a senior fellow at the Tax Policy Center. "What do you do about that?"

U.S. workers and their employers each contribute 7.65% of the employees' gross pay for Social Security and Medicare through the payroll tax. Tweaking this tax to stimulate the economy is not unheard of.

A 2011 payroll tax cut to counteract the Great Recession, for example, returned $109 billion to households by cutting two percentage points from the amount that employees pay to the federal government. In that case, the Treasury put a similar amount into the social security fund to make up the loss.

Trump's proposal, to eliminate both the workers' and employers' payments, is of a different scale. Unless it is also somehow replaced, it could exacerbate funding shortfalls that the two popular programs already face in coming years, as the U.S. population ages and demand for health care increases.

Nearly 90% of Social Security's budget https://www.ssa.gov/news/press/factsheets/HowAreSocialSecurity.htm came from payroll taxes in 2018, according to U.S. government figures. Medicare, which provides 18% of the U.S. population with health insurance, was 36% funded from payroll taxes in 2018, reports https://www.pgpf.org/budget-basics/medicare the Peter G. Peterson Foundation, a Washington think tank.

If Trump were successful in making the payroll tax cuts permanent, he would hope to fund Social Security and Medicare from general revenue, a Republican source says.

That move could balloon the U.S. budget deficit, which will top $1 trillion this year, despite the strong economy, the CBO estimates.

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Congressional leaders from both parties were skeptical the idea would fly.

The idea of a payroll tax cut is a "non-starter" and will not be included in Democrats' stimulus legislation, House majority leader Steny Hoyer said Wednesday.

Democrats are not interested in the idea, U.S. Senator John Thune, a member of the Republican leadership, told Fox News Wednesday. But, he said, the payroll tax remains a "big component" of the president's stimulus plan.

DO PAYROLL TAX CUTS WORK?

Moody's Analytics estimated that a full pandemic, with 3 million to 4 million infections globally, might lead the U.S. economy to end 2020 about 1.5% smaller than it was at the end of 2019, ending a decade-long expansion.

It is not clear a payroll tax cut would offset even a milder shock.

During the Great Recession, the U.S. government's all-hands-on-deck fiscal response included industry bailouts, and a variety of tax cuts and stimulus payments. The moral of the story then was that sending people larger checks all at once works better than parceling money out a paycheck at a time.

Of the $100 billion in one-time stimulus checks mailed to 130 million people in 2008, up to 90% got spent, according to 2011 research on the program's impact.

Smaller sums tucked into weekly paychecks in the form of a payroll tax cut were spent at about perhaps half that rate, according to research by the New York Fed, with the rest saved or applied to debt.

"Right now is when people are freaking out," said Claudia Sahm, director of macroeconomic policy at the Washington Center for Equitable Growth. "They don’t need an extra 50 bucks in October. They need an extra 500 bucks now," to allay fears about lost jobs or wages, pay for medical tests, or ease the need to cut back spending right away.

Sending $500 per person right away, at a cost of around $165 billion to the government, could act as a sort of circuit breaker to avoid a recession and boost confidence among households, she said.

Senator Ron Wyden, the ranking Democrat on the Senate Finance Committee, said Tuesday the tax cut would not necessarily help the most vulnerable workers.

To benefit from a payroll tax cut, first of all, you need to be employed, he said.