December 4, 2001

December 4, 2001 | WebMemo on Taxes

The Domenici Payroll Tax Holiday: Bad Policy for America

Last month, Sen. Pete Domenici (R-NM) proposed that the payroll taxes devoted to social security be suspended for the month of December in order to strengthen the nation's sagging economy. Both employers and employees each pay 6.2 percent of earnings to fund the program, up to the current 2001 wage cap of $80,400.

The Domenici proposal is bad policy for America on three basic levels.

1. The Domenici Plan will not increase employment.
The Department of Labor reports that some 887,000 workers have lost their jobs between March and October, but none of them will be rehired into permanent jobs because of a one-month holiday. Only the prospect of putting tax money permanently back into businesses will induce them to invest, expand, and hire more workers, and if individuals can save more of their tax dollars, then they may be able to open up their own businesses and employ their own workers.

Employers know that this idea is little more than a very short-term gimmick.

2. The Domenici Plan will not stimulate the economy.
The hope is that people will spend the tax holiday proceeds on new purchases, increasing consumption, which in turn drives the economy forward. The last time this was tried, though, Americans were largely unwilling to do that.

About the time the summer tax rebate checks were issued, ABCNEWS and the Washington Post conducted a poll, asking people how the checks would be spent. They found that the overwhelming majority of families - over seventy percent - would do something other than spend the money on new purchases.

Newly revised data released by the Bureau of Economic Analysis (BEA), a division of the Commerce Department, confirm this. Personal consumption expenditures between June and July 2001 (on an annualized basis) increased less than $18 billion while savings increased more than $110 billion. Consumption between July and August 2001 increased slightly more than $10 billion, but savings increased by more than $135 billion. Because of the way BEA makes the calculation, total savings includes money used to pay down existing debt.

In short, if the Domenici legislation is enacted, most people will not spend it; rather, they will pay down debts or save it, just like they did last summer.

3. The Domenici Plan is a shell game and little more than redistributionary tax policy.
The Heritage Center for Data Analysis estimates that a December 2001 tax holiday will cost the social security trust fund nearly $44 billion. If the tax holiday is postponed until January 2002, the cost will balloon to over $52 billion since those individuals earning more than the social security wage cap will be able to take advantage of the holiday in 2002.

Sen. Domenici pledges that the federal government's general revenue will cover all losses to the social security trust fund. While this may sound appealing, this is simply a shell game, and these billions of dollars must come from somewhere. The $44 billion will first come from more deficit spending, since the surplus dried up because of the economic downturn and spending on programs related to September 11. The national debt will someday be paid off with revenue from individual and corporate taxes. These taxes, then, are paid by the middle and upper classes to replenish the trust fund that is used to pay retirees, who typically pay very little in taxes.

In short, this plan is nothing more than a Keynesian redistribution scheme that steals from Peter to pay Paul.

What Congress Should Do

Instead of relying on gimmicks to spur the economy, Congress should enact real reforms in the tax and social security areas:

Enact and Accelerate Permanent Tax Reforms.
The provisions of this year's tax bill should be accelerated to move the economy forward. Specifically, the tax rate cuts that will be fully phased-in by 2006 should be enacted now so they benefit American workers this year. In a speech this week here at The Heritage Foundation, Glenn Hubbard, chairman of President Bush's Council of Economic Advisers, calls this kind of policy "growth insurance" for the economy. Cutting taxes now will help insure that America's economy moves forward, not backward, in the coming months.

Other provisions, such as the increase in the child tax credit, marriage penalty relief, and the elimination of the estate tax should also be accelerated to this year. Also, Congress should seriously consider eliminating the individual and corporate Alternative Minimum Taxes.

Enact Real Social Security Reform.
The President's Commission to Strengthen Social Security is set to release their final report later this month. Congress should take this opportunity to allow individual workers to save and invest a portion of their own social security dollars into their own Personal Retirement Accounts. Younger workers especially will find themselves far better off at retirement with income from their PRAs than with the paltry returns social security yields. Additionally, more money flowing into equity markets will increase the amount of capital available for new investment. At the same time, an increasing number of Americans will build wealth that they never had before, wealth they can spend in their own retirements or give as a bequest to their heir, church, or preferred charity.

Conclusion

In this holiday season where people are worried about the economy's future, America deserves a real present from Congress. Instead of a stimulus plan that is little more than a lump of coal, America needs real and lasting reform in tax and social security policy. Clearly, the Domenici tax holiday plan falls short.

Kirk A. Johnson, Ph.D. is a Senior Policy Analyst at The Heritage Foundation's Center for Data Analysis.

About the Author

Kirk A. Johnson, Ph.D. Visiting Fellow
Center for Data Analysis