Saving Entitlements By Cutting Taxes

In the previous issue of National Review (2/22/2010), an article by George Gilder lays out the rationale for a payroll tax cut. (Being generally put off by wonkish discussions of tax policy I had initially passed over the piece). Gilder notes that advocates for such a move include such disparate figures as Massachusetts Senator Scott Brown, former Clinton Labor Secretary Robert Reich and former Republican VP candidate Sarah Palin. Gilder doesn't support the cut for the usually expressed reasons - for providing employers with more money to pay wages and hire workers or for helping poor and middle-income wage earners make ends meet or for allowing workers to keep more of what they earn or for creating jobs.

The main reason Gilder supports a payroll tax cut is because it would incentivise retired and soon to retire older workers to remain in the workforce. With the surge of baby boomers leaving the workforce and drawing down their promised Social Security and Medicare benefits there will be left a smaller cohort of younger workers carrying an increasingly heavier burden. Gilder wants to stanch the seniors' stampede to the exits with a cut in payroll (SS and Medicare) taxes. This contraintuitive approach - cutting the revenue sources of those entitlements to save them - would work by improving economic productivity. It would increase the proportion of what Gilder calls "real" revenue. That is, revenue generated by the production of life enhancing goods and services rather than funds merely seized by the government. Gilder points out the following.

Employees now pay 6.2 percent of wages, and employers match this, for a total of 12.4 percent of earnings up to $106,800. In addition, 1.45 percent of wages are withheld, and matched by the employer, for Medicare, with no earnings cap. If you opt out of this system and retreat to self-employment, you will have to pay 15.3 percent of your income into Social Security and Medicare.

Such steep labor costs stifle new business creation and hiring. With small businesses estimated to provide 70% of new jobs, that 15.3% is an especially powerful drag on the economy. Gilder adds,

These imposts come on top of income and corporate taxes that bring total levies on the output of productive employees to a marginal level near 50 percent, with the rates rising in 2011 at both the state and federal levels.

...This tax structure induces the retired to avoid new income, which is diminished nearly dollar-for-dollar by benefit reductions. Yet the best way to sustain the ever-increasing burden of health-care spending is by keeping skilled and experienced workers at work, where they add real value to the economy. Skilled workers create and maintain jobs for others and enhance the productivity of the entire work force. Today, such workers may find their skills more favorably employed on golf courses and beaches than in mentorships and consultancies.

Or by recording enlightened musings in a blog.

As a new member of that ever growing retiree population, I have little financial incentive to re-enter the job market and generate real government revenue. Much better for me to draw from the entitlement pool than to add to it. As for taxes, one reason I've been able to retire is that my much smaller yearly income is minimally diminished by the highly progressive income tax system and not at all by payroll taxes. I was (very pleasantly) surprised that I had substantially overestimated my income tax last year and will be receiving a hefty tax refund. Rewarded for not working! I think I can learn to like those liberal Democrats!

But I am fortunate that I've been able to accumulate enough wealth over the years which, along with a pension, generates sufficient income for a comfortable lifestyle. What of those not so fortunate? Well, they may need to continue to work, but have little incentive (financially speaking) beyond just showing up. Why bother working longer and harder, generating new ideas, innovating, increasing productivity, when the government will just take a larger share of the compensation for those efforts? Why use the skill and knowledge developed over a lifetime to embark on a new, private enterprise when, with the payroll tax, the feds will take, right off the top, over 15% of the profits? Then, if successful, the job creating entrepreneur is punished further with confiscatory tax rates. And with President Obama and Congressional Democrats threatening to impose additional penalties on income over $250,000 (or is it $200,000?) to pay for their awful cap and tax and health care "reform" plans, is it any wonder there's so much negative sentiment about the future?

George Gilder has a simple prescription for this malaise.

...reduce the payroll tax by at least a third. Then we should move toward a flat tax. Lower tax rates will mean more jobs and income for Americans of all ages, higher values for our equities and other assets, and the building up of real capabilities — as opposed to federal accounting balances.

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