The Cut That Heals

George Gilder
National Review
February 22, 2010
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For the last ten years or so, I have been urging drastic reductions in the U.S. payroll tax, which funds Social Security. If we want to reduce tax rates without falling into the rhetorical trap of “tax cuts for the rich,” then the payroll tax is our best target — and the one that will affect the most employment decisions. Now I am feeling the heat of the herd as bipartisan throngs join me in the cause. An unharmonious choir of politicians and thinkers, most of whom agree on little else, is singing the virtues of cutting the payroll tax. Among them are Clinton labor secretary Robert Reich, Massachusetts miracle Scott Brown, Alaskan rogue Sarah Palin, the American Enterprise Institute’s John Makin, economist Russell Roberts of George Mason University, and former Bush advisers Larry Lindsey and Michael Boskin. 

Why do I mute my cheers? Because none of these would-be tax cutters articulates the only plausible goal for a payroll-tax rate reduction. What is that? To flood employers with more money to pay wages and hire workers (Boskin)? To help poor and middle-income wage earners make ends meet (Palin)? To diminish the wedge between what employers pay and what workers receive (Lindsey)? To create jobs (Reich)? 

None of the above. However desirable each of these goals may be, cutting the payroll tax without cutting spending — or at least reducing spending relative to the output of the economy — means that all the hypothesized revenue to support federal appropriations still comes from the income and output and savings of other employers and employees. If the result of a payroll-tax cut is to deplete available funds for Social Security, it is politically perilous and undesirable. The solution is to be found in a tax cut that is part of an overall pro-growth agenda: one that does not merely address the balances on government accounting ledgers but increases the value of our assets and the output of real goods and services in our economy. 

Today, both supporters and critics agree that cutting the tax will reduce funds for retirees at a time when existing funds are barely adequate. According to Roberts, using the $200 billion of unspent TARP funds to cut the payroll tax by 25 percent for the next five years would “reduce revenue by about $250 billion per year.” Opposing the same proposal, former supply-sider Bruce Bartlett agrees that a payroll-tax cut “will involve a considerable loss in revenue to the Social Security Trust Fund. He called the proposal “a dreadful idea.” 

Dreadful indeed is a cut in payroll taxes that will reduce government revenues, jeopardize Social Security, and, under the congressional pay-as-you-go rules, require “compensatory” spending cuts that hurt Republicans and undermine our national defense. Payroll-tax cuts treated as spending cannot achieve the real benefits that tax-cut advocates seek: new and preserved jobs, new small businesses, an expanded economy. 

The only reasonable and politically attainable goal of a payroll-tax rate reduction is to get as much real revenue for the government as possible. A tax-rate reduction that increases real government revenues by definition also increases the private sector’s share of a larger economy: If rates are down and revenue is up, then taxable earnings must be growing. Everybody wins — except the politicians who oppose it. 

The stress is on the word “real,” meaning actual goods and services that can enhance the lives of old people. The best way to enhance the lives of old people is to keep them healthy and at work, paying taxes rather than consuming them. But the ongoing debate treats the number of retirees as static, and accumulated accounting balances as tantamount to real support in the future. Accounting balances built up by punishing work and enterprise — as our current tax system does — are the problem, not the solution. Far from enabling future growth and support for the elderly, our current policies merely subsidize retirement with specified numbers of dollars. Recycling these dollars through President Obama’s political process will eventually shrink them down to the value of a ticket for a place in line at a government office harboring a lottery “lock box” run by ACORN. 

Unless an action today plausibly increases the quality of life for the tsunami of boomer fogeys coming down the demographic pike over the next two decades like the addled throngs on the road to Woodstock in 1969, it is probably both destructive and politically unsupportable. This generation is going to need a lot of expensive new stuff: prosthetic knees and hips, cardio stents and defibrillators, cancer treatments, diabetes relief, soft forms of fibrous nutrition, comfy recreational vehicles, fat farms and surgeries, golf courses, motorized wheelchairs, broadband networks, guards with guns at the gate. 

Under Obama, what they will get is value-subtracted services such as unionized educational and security bureaucrats who obstruct learning and safety, labyrinthine health-care money shuffles and legal hustles that drive doctors out of hospitals and into mental institutions, new layers of regulators to harass anyone retaining some investable savings, and “green jobs” in the CO2-suppression business that yield no benefits at all to anyone but the carbonated hustlers who supply the “green” paint and agitprop. 

The goal of real support for old people imposes an affirmative discipline on the entire economy: To sustain the coming masses of retirees, the economy must increase its productivity and the flow of innovative services dramatically over time. By contrast, maintaining high-and-rising tax rates today means a smaller economy tomorrow, with lower values for equities and assets — meaning less ability to sustain debt or to support retirees, or anyone else, with innovative goods and services. 

Central to the problem is the payroll tax. 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. 

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. At this point, an employer has more incentive to hide or shelter a dollar of existing income than to incur the stress of employing a worker to earn a dollar of new income. Meanwhile, by zeroing out the tax burden near the poverty line, the earned-income tax credit gives the system an oppressively “progressive” bias that discourages earning and aspiration. 

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. 

Cutting the payroll tax is the best way to rectify an increasing bias in the economy in favor of retired old people and against the productive of all ages. The U.S. is mimicking Europe in transforming the young and ambitious into retirees or émigrés, with lost generations of youth and ever earlier retirements on the Riviera. But all the talk about how federal debt dooms our youth to a future worse than what our current boomers enjoy is true only to the extent we continue to saddle the young with counterproductive levies on their work as we drive healthy older workers into retirement. 

The only way to make our current debt burdens manageable is to improve our economic environment and thus the value of the some $100 trillion in U.S. assets. Under Reagan, for example, an increase of $1.4 trillion in federal debt was dwarfed by a $17 trillion increase in the value of private assets. A particular source of increasing valuations could be the health-care industry — which will necessarily attract more funds as the population ages, and whose innovations will help extend productive careers by decades. From the completion of a worldwide fiber-optic broadband Internet to cornucopian energy advances, the global economy is engaged in a campaign of accelerating innovation that will unify it and enrich it as time passes. The U.S. can continue to prosper if we allow the billions of younger workers around the globe to use their increasing savings to buy the assets of American seniors as they grow older. This will offer liquidity to our retirees, sustain U.S. asset prices, and expand American opportunities. 

The U.S. will also need to remain open to overseas innovations and policy improvements. Israel under the Netanyahu government is a creative extension of Silicon Valley that offers a haven for American enterprise and finance, which are increasingly stultified in California and New York. China is a bastion of strength for the dollar in the face of those who wish to weaken our currency to promote trade. Many countries offer valuable resistance to Obama’s global-warming obsessions, which threaten to destroy America’s energy prospects. 

As a pay-as-you-go transfer scheme, Social Security is currently working fine. By ending the myth that somehow Social Security taxes are building up reserves for the future, we can 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. It’s a policy that can win for Republicans and for America. 

Mr. Gilder is editor-in-chief of Gilder Technology Report and co-founder of the Discovery Institute.