Payroll tax cut raises worries about Social Security’s future funding

By Jia Lynn Yang

By extending the payroll tax cut, Congress and the administration have quietly made a critical change in how Social Security is funded — one that some in Washington worry could undermine the program’s foundation if lawmakers keep renewing the tax break.

For the first time in the program’s history, tens of billions of dollars from the government’s general pool of revenue are being funneled to the Social Security trust fund to make up for the revenue lost to the tax cut. Roughly $110 billion will be automatically shifted from the Treasury to the trust fund to cover this year’s cut, according to the Social Security Board of Trustees. An additional $19 billion, it is estimated, will be necessary to pay for the two-month extension.

The tax cut is supposed to be temporary. But as squabbles over this issue and the Bush tax cuts have revealed, short-term tax cuts in Washington have a way of sticking around longer than planned, especially as economic growth remains slow and lawmakers are wary of raising anyone’s tax bill.

The prospect of policymakers continually turning to the payroll tax as a way of providing economic stimulus troubles experts, some lawmakers and both public trustees of the Social Security trust fund. Their concern: that Social Security will lose its status as a protected benefit owed to every working American and instead become politically vulnerable, just like any other government program.

And as this year’s debate about the nation’s debt showed, nothing is off limits to the political brinkmanship that has come to dominate Washington.

“It’s a grave step for Social Security,” saidCharles Blahous, one of two public trustees for Social Security and a research fellow with the Hoover Institution. “It just seems to me the program both financially and politically will be on a lot rockier footing.”

Robert Reischauer, the other public trustee and president of the Urban Institute, said extending the payroll tax cut another year during high unemployment seems justified. But it “could, if it continues for a substantial period of time, undermine one of the foundational arguments that makes the Social Security program inviolate.”

Since its inception under President Franklin D. Roosevelt, the Social Security program has been premised on a simple contract: Americans pay into the program’s trust fund over years of paychecks through the payroll tax. In return, when they retire, they receive monthly benefits.

The payroll tax cut changes that. Instead being a protected program with its own stream of funding, Social Security, by taking money from general revenue, becomes more akin to other government initiatives such as Pentagon spending or clean-air regulation — programs that rely on income taxes and political jockeying for support.

“All of a sudden Social Security will have to compete with every other program, whereas before it had its own dedicated revenue,” said Nancy Altman, co-director of Social Security Works, an advocacy group. “It’s breaking the kind of firewall that has always existed between the trust fund and the operating fund.”

She added: “The biggest concern is that this was done without any hearings, without any apparent regard for the impact on Social Security.”

The chief actuary of the Social Security trust fund has affirmed that the payroll tax cut will not put a dent in the $2.6 trillion fund, which is expected to pay all promised benefits until 2036. The law requires the government to make up any shortfalls.

The fund has been built up over time by contributions from the 12.4 percent payroll tax, of which employees and employers each pay 6.2 percent. The temporary tax break reduced the share paid by employees by 2 percentage points.

Altman said that the tax had never been reduced before, and the most it has been raised at any time is 0.5 percentage points.

“We’ve never really monkeyed around with Social Security before,” said Blahous. “Until now it was understood the payroll tax was supposed to do one thing. It wasn’t supposed to be a stimulus mechanism. Now the payroll tax is this variable thing that goes up and down according to other economic conditions. That is a real transformation of what that money is supposed to do.”

The pressure to cut the tax came from the country’s slow-growing economy. Last December, Republican lawmakers fought to extend the George W. Bush tax cuts, which were about to expire, while the White House pushed for a tax credit called Making Work Pay. Their compromise: a two-year extension of the Bush tax cuts, a year of extended unemployment benefits and a one-year payroll tax cut that effectively replaced Obama’s tax credit idea.

Last year’s payroll tax cut saved the average U.S. household more than $900, according to the Tax Policy Center.

During the fight earlier this month, Democrats borrowed from the Republican playbook, arguing that reverting to the old rate would be a tax hike. And economists worried that allowing the cut to expire would dampen economic growth in 2012 by as much as two-thirds of a percentage point.

The payroll tax cut could be here to stay for a while. Senate Majority Leader Harry M. Reid (D-Nev.) has said he will appoint a conference committee to search for ways to extend the two-month cut for all of 2012.

Blahous said Social Security will be facing enough financial pressures in the years to come without the payroll tax cut complicating matters.

This year, the Social Security system projects that it will pay out $46 billion more in benefits than it will collect in cash. It made up for the shortfall by redeeming Treasury bonds bought in years when there were cash surpluses.

Lawmakers on both sides of the aisle, including Sen. Bernie Sanders (I-Vt.), Sen. Jon Kyl (R-Ariz.) and dozens of House Democrats, have expressed concerns about the impact of the payroll tax cut on Social Security.

“Whether you’re on the left or the right, you should really dislike this,” said Blahous. “It has been somewhat mystifying, the determination to do this. I just think it’s shortsightedness.”