payroll-tax-holiday.pngTaxpayers are merry about legislation Congress recently passed and President Obama signed into law to extend for another two years income tax rate cuts that were set to expire on New Year’s Eve. The legislation also cuts Social Security taxes by two percentage points for 2011, from 6.2% to 4.2%.

The special payroll tax break will reduce the Social Security taxes of workers who earn $50,000 by a total of $1,000 in 2011. Workers who earn the maximum Social Security wage base of $106,800 will see a total tax cut of $2,136. And a two-worker household earning a total of $100,000 will see a $2,000 cut in their combined Social Security taxes. This is surely a Christmas present that will keep giving all through the year 2011!

There’s only one problem with this payroll tax “holiday:” Like Dickens’ Ebenezer Scrooge, we’re about to be visited by the Ghost of Christmas Future. The 2 percentage point cut in payroll taxes shoots a $112 billion hole in a Social Security trust fund already on the verge of insolvency. Read more.

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Payroll Tax Holiday: Ghost of Christmas Future?

Wed Dec 22, 2010

payroll-tax-holiday.pngTaxpayers are merry about legislation Congress recently passed and President Obama signed into law to extend for another two years income tax rate cuts that were set to expire on New Year’s Eve. The legislation also cuts Social Security taxes by two percentage points for 2011, from 6.2% to 4.2%.

The special payroll tax break will reduce the Social Security taxes of workers who earn $50,000 by a total of $1,000 in 2011. Workers who earn the maximum Social Security wage base of $106,800 will see a total tax cut of $2,136. And a two-worker household earning a total of $100,000 will see a $2,000 cut in their combined Social Security taxes. This is surely a Christmas present that will keep giving all through the year 2011!

There’s only one problem with this payroll tax “holiday:” Like Dickens’ Ebenezer Scrooge, we’re about to be visited by the Ghost of Christmas Future. The 2 percentage point cut in payroll taxes shoots a $112 billion hole in a Social Security trust fund already on the verge of insolvency.

Just this past August, Social Security trustees reported that “Social Security expenditures are expected to exceed tax receipts this year for the first time since 1983,” a shortfall of $25 billion for 2010. They also said that, “After 2014 deficits are expected to grow rapidly as the baby boom generation’s retirement causes the number of beneficiaries to grow substantially more rapidly than the number of covered workers.”

In other words, payroll tax receipts are already less than Social Security benefits paid, the shortfall is expected to grow rapidly, and the new payroll tax holiday will reduce tax receipts by another $112 billion!

What will happen? As Allan Sloan writes in the December 21, 2010 Washington Post, (New tax law shows futility of Social Security trust fund — the U.S. Treasury will give the Social Security Administration (SSA) $112 billion in special new bonds to offset the 2 percentage point gap in payroll tax receipts. The SSA will redeem these bonds as needed to pay Social Security benefits.

Where will the Treasury get these new bonds? Writes Mr. Sloan, “Treasury isn’t selling bonds to Social Security; it is creating them out of thin air and putting them into the trust fund. The missing cash? Uncle Sam will just borrow $112 billion from somewhere.” In short, the U.S. Treasury will make up the lost Social Security tax revenue by issuing more government debt.

This gets us back to Ebenezer Scrooge and the visit of the Ghost of Christmas Future. The payroll tax holiday — welcome as it is — must one day be paid for. Sooner or later the U.S. government will need to pay principal and interest on the bonds issued today to pay for these tax breaks. We can only hope that by then the economy will be booming, full employment will have returned and, like Dickens’ “A Christmas Carol,” it all has a happy ending.