The two mushy, aspirational parts of the August 8 presidential memorandum to Treasury on the deferral of the employee portion of Social Security taxes are at the beginning and the end.
President Trump begins the one-page document by stating that his intention is “to put money directly into the pockets of American workers.” And he concludes by directing Treasury Secretary Steven Mnuchin to “explore avenues, including legislation,” to convert this deferral into a permanent tax cut. These hoped-for outcomes are questionable.
The more grounded middle paragraphs state that for four months — from September through December — Treasury will “defer withholding, deposit, and payment” of the 6.2 percent of wages and benefits deducted from employee salaries for payment into the Social Security Trust Fund. The memo states that this only applies to workers whose salaries “generally” are less than $4,000 per biweekly pay period ($104,000 annualized). (Yes, that creates a cliff effect, but we suppose Treasury might change this when it issues guidance later this month.)
So for the time being, let’s not get distracted by the much-alleged illegality of the memo and the certainly uncertain legal implications for employers and use arithmetic to get a feel for the amount of money at stake here.
Under the memorandum, for an individual worker making $102,000 annually, 6.2 percent of $34,000 will be deferred. That’s $2,108 over four months, or approximately $124 per week. For workers earning $51,000 (much closer to the national median of $52,000), the total is $1,054 over four months, or approximately $62 a week.
For folks who care about politics, the election is right in the middle of the four-month September-December deferral period. So only half these amounts would materialize before the election. And keep in mind that families with multiple earners can get multiple reductions. (Presumably, coming Treasury guidance will prevent workers with more than one employer paying more than $4,000 per pay period from receiving extra benefits.)
What does this mean for the overall economy? Because of the COVID-19 shock, employment levels are about where they were in 2014 (that is, 144 million Americans employed). In that year, the Social Security Trust Fund received about $750 billion in payroll tax (as well as about $30 billion from income taxation of Social Security benefits and about $100 billion in interest). One-half of that was from employers, and the memo only applies to one-third of the year. So we can multiply that total by one-sixth to get $125 billion.
According to Labor Department data, about 85 percent of employees earn less than $2,000 per week. On average, each of those high-wage workers contributes roughly double that of the other workers, so about 30 percent of payroll tax collection would not be covered by the memo. That leaves us with $88 billion of employee payroll tax deferral authorized by the memo.
This is all back-of-the-envelope, but any way you count it, this tax deferral is quite a bit less macroeconomic stimulus than would be provided by the over $400 billion of tax cuts and refunds from a second set of recovery rebate checks.
Puzzling Possibilities
Let’s look at mechanics. Under normal circumstances, employer payroll tax is deducted from pay by the employer. The employer pays Treasury. That is from section 3102(a) of the code. An employer is obligated to pay Treasury or get slapped hard with penalties under section 6672. No fooling around. The IRS can assess a 100 percent trust fund recovery penalty on “responsible persons” in the employing business.
Don’t mix all this up with section 3402(a), which requires employers to withhold income tax from employees’ wages. That section authorizes Treasury to provide employers with withholding tables. That’s why President George H.W. Bush in 1992 could unilaterally reduce withholding on income taxes. The 1992 presidential directive for reduced income tax withholding provides no precedent for reduced payroll tax withholding in 2020. There are no withholding tables for payroll taxes. Employers must simply remit to Treasury the tax as set in statutory law.
What does seem to give the president clear authority to defer payroll tax is section 7508A. According to this provision, in an area and during the time of a presidentially declared disaster, Treasury has wide discretion to postpone filing, tax payments, and all types of tax-related deadlines. On March 13 Trump declared the COVID-19 outbreak a nationwide disaster, and that declaration is still in force.
So what can happen now? Employers basically have three choices beginning in September. First, they could increase take-home pay and stop making payments of employee payroll tax to the IRS. That is the outcome sought by the White House. Second, employers in theory could keep employee take-home pay constant and keep the unremitted cash (presumably in an account not available for general business purposes). But there should be no expectation of this. If an employer withholds and doesn’t deposit, it is subject to penalties under sections 6656 and 6663, and these penalties weren’t waived in the presidential memorandum. Third, employers can do as they have always done — that is, deduct the payroll tax from salary and pay it to the IRS. This would be ignoring the order in practice.
Now, the implications of those three possible courses of action depend on the subsequent action or inaction of Congress. If there is no subsequent legislation to convert the deferred taxes into forgiven taxes, all that has happened is that Treasury has made an interest-free loan: to employees (if employers increase take-home pay); to employers (if employers set the money aside); or to nobody (if employers pay the tax anyway).
The problem with the interest-free loan in the first case — that is, the interest-free loan to employees — is that the employer is on the hook to repay it. Can the employer try to get the money back from employees? What about employees who have left the employer’s business? Could the employers withstand the employees’ disgruntlement at having their take-home pay decreased below what it was before September? Is it even legal to request or require catch-up payments from employees? These awkward questions about the first option and the penalties under the second option are good reasons for accountants and boards of directors to advise caution and choose option two or three. But that risks incurring the backlash that could result from frustrating presidential intent and disappointing employees who might be expecting (or at least hoping for) larger paychecks starting in September.
If a law is enacted to forgive the deferred payroll tax, matters for employers would be easier. If they had increased take-home pay, employees and employers unquestionably would never need to worry about repayment. If employers did not increase take-home pay but did not remit the funds to the IRS, subjecting themselves to penalties, they would presumably be required to pay employees a lump sum amount. (A check could accompany the Form W-2 sent to employees who had moved on.) For employers that continued remitting employee payroll taxes despite the August 8 memorandum, they would have overpaid payroll tax. One possibility would be for them to file for refunds and then use refunds to reimburse employees.
Macroeconomics and Macroconfusion
If the payroll tax deferral remains unforgiven, the impact on the economy will be small and temporary. As Stuart Butler of the Heritage Foundation told the House Ways and Means Committee in 1992: “Altering withholding schedules does nothing to increase incentives to work, save, and invest.” That is, unless a significant portion of workers perceived the increase in take-home pay as permanent. This false stimulus would be good for the economy in the short run but would certainly make folks angry in 2021.
If the payroll tax is forgiven, it has a smaller and slower bang for the buck than an outright ex ante tax cut with the same price tag because, just as some folks would be fooled into believing it was a tax cut and not a deferral, others would expect it to remain a deferral and not spend the extra cash until it was clear legislation would be passed.
One complaint about the August 8 memorandum that seems overblown is its effect on the solvency of the Social Security Trust Fund. If there is no loan forgiveness, all that the trust fund loses is approximately two months of 1 percent interest on $88 billion of deferred taxes — a mere $150 million. If the deferral is legislated into a tax cut, there is no reason why the legislation cannot make up the $88 billion difference. In 2011 and 2012, Congress allowed the transfer of $220 billion from the general fund to the Social Security Trust Fund, so the effect of a payroll tax cut wouldn’t hurt the fund’s solvency.
Some of the confusion about employer responsibilities will be cleared up when Treasury issues guidance later this month. But the fundamental uncertainty about tax deferral or tax forgiveness may not be adequately resolved, perhaps well into 2021. It is not pleasant for the mass of workers and small business owners who lack the financial savvy to deal with all of this. Even the largest businesses face tough choices.
Temporary, rushed tax policy by executive order, whose ultimate result depends on highly uncertain future legislation, is a messy process. Whether it’s worthwhile from an economic perspective is a difficult call. But who cares what economists think? Partisan politics will dominate the debate. Or maybe all of this will just turn into a fleeting memory if Congress and the president can get back on track and make a deal.