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The Payroll Tax Cut
The payroll tax cut is frequently viewed as small, as it is generally expressed as a “two percent” cut.At the nominal, unexamined level, “two percent simply sounds small.”
However, for most people, the cut amounts to a 2% increase of their actual salary, which is not small. For many, it is the only “raise” they have received this year.
What type of impact does the payroll tax cut have on the Social Security system, however?
The Social Security Trust Fund
There actually is no Social Security Trust Fund, by that name.
The actual name is “the Federal Old-Age and Survivors Insurance Trust Fund” (OASI). This is the fund that pays retirement benefits.
When talking about the Social Security system in general terms, however, most people include the Disability Insurance Trust Fund (DI) with the Old-Age and Survivors Insurance Trust Fund. The disability insurance trust fund makes disability payments to applicants whose disability is deemed covered.
The combined funds together are what is generally meant by the “Social Security Trust Fund.” The government refers to the combined funds by the abbreviation of OASDI.
For the purposes of this column, we will list both funds separately and combined in the numerical tables.
Revenue For the Social Security Trust Fund
Both the OASI fund and the DI fund are funded by the payroll taxes affected by the proposed payroll tax cut of 2%.
The funds also receive income from the interest on US Treasury debt that it holds.
As published in the 2011 Annual Report by the Social Security Administration, the Old-Age and Survivors Trust Fund and the Disability Trust Fund had revenue in 2010 from the following sources:
| Revenue Source $B | Social Security Trust Fund (OASDI) | OASI | DI |
|---|---|---|---|
| Payroll Tax | $637.3 |
$544.8 | $92.5 |
| Interest Earned | $117.5 | $108.2 | $9.3 |
| General Fund Reimbursement |
$2.4 | $2.0 | $0.4 |
| Taxes on benefits | $24.0 | $22.1 | $1.9 |
| Total Revenue | $781.2 | $ 677.1 | $104.1 |
Source: Social Security Administration 2011 Annual Report
We have chosen to use the 2010 actual results as the basis for our analysis because payroll taxes and other sources of income are clearly itemized. In most projections of Social Security operations, this level of detail is omitted. Using the 2010 actual results allows us to isolate the impact of the 2% payroll tax, while assuming that the other sources of revenue stay the same.
Operating Results In 2010
The following table summarizes the operating results of the Social Security System in 2010. Again, we have provided the Old-Age Survivor Insurance Fund and the Disability Fund in both individual and combined presentation.
| 2010 Actual Results | Social Security Trust Fund (OASDI) | OASI | DI |
|---|---|---|---|
| Revenue, 2010 | $781.2 |
$677.1 | $104.1 |
| Outlay, 2010 | $712.6 | $584.9 | $127.7 |
| Net Change In Assets | $68.6 | $92.2 | -$23.6 |
Source: Social Security Administration 2011 Annual Report
Note that the while the combined trust funds showed an increase in assets, as outlays exceed revenue, the disability fund does not show an increase in assets and that lowers the total increase in assets significantly.
With all of this as background, we can now examine the impact of continuing the 2% payroll tax cut.
Impact Of The Payroll Tax Cut
Using the 2010 data as a reference point, we can calculate the scale of the impact of the 2% payroll tax cut.
Analyzing the data in 2010 provides an answer to “what would have happened if the 2% tax cut were in place in 2010?”
This is a slightly different approach than using projected numbers for 2012, but for the purposes of gaining a feel for the impact of the cut on the Social Security System, we think this approach is more helpful.
Using the assumption that the revenue numbers for the OASI and DI funds were both entirely due to a complete 12.4% payroll tax collection, we can calculate the impact of cutting that revenue to a level of 10.4%.
These assumptions mean that if revenue in 2010 for the funds had been based on 10.4% payroll tax, rather than on the 12.4% rate, payroll tax revenues would have been just 83.9% of the actual taxes received (10.4 / 12.4 = 0.839).
This means that the revenue in 2010 for the Social Security Trust funds would have been as shown in the following table.
| 2010 Revenue, $B | Social Security Trust Funds (OASDI) | OASI | DI |
|---|---|---|---|
| Payroll tax at 10.4% | $534.5 | $456.9 | $77.6 |
| Interest earned | $117.5 | $108.2 | $9.3 |
| General Fund Reimbursement | $2.4 | $2.0 | $0.4 |
| Taxes on Benefits | $24.0 | $22.1 | $1.9 |
| Total Revenue | $678.4 | $589.2 | $89.2 |
Source: Briefing.com calculations
These results make the operating results of the Social Security Trust Funds look very different than they did with the payroll tax at a full 12.4%, as can be seen when these new total revenue numbers are applied to the 2010 operating results.
Impact of Theoretical Cut in 2010 Operating Results
The following table illustrates the results that the Social Security funds would have had in 2010, if a 2% payroll tax had been in place that entire year.
| 2010, $B | Social Security Trust Funds (OASDI) | OASI | DI |
|---|---|---|---|
| Total Revenue, 10.4% payroll tax | $678.4 | $589.2 | $77.6 |
| Outlays | $712.6 | $584.9 | $127.7 |
| Net change in assets | -$34.2 | $4.3 | -$38.5 |
Source: Briefing.com calculations
Note that while the fund dedicated to retirement funds is still positive, the disability fund’s shortfall is large enough to result in a combined Social Security Trust Fund decline in assets.
Possible Impact In 2012
Although we do not have a current 2012 projection for Social Security with detailed projections of individual revenue sources, we do have projections of the revenue and outlays for the funds in 2012, as part of the Social Security Administration 2011 Annual Report.
If we make the assumption that the impact of a 2% payroll tax cut on total revenues (which lowered 2010 total revenue to 83.9% before the tax cut), then we can adjust the Social Security Administration's own projections of 2012 revenue and outlays by assuming that 2012 total revenues will be 83.9% of the projected revenues (which were based on a 12.4% payroll tax level).
The following table illustrates the change in the operating results of the funds, using the assumption of no payroll tax cut.
| 2012 Projections $, B |
Social Security Trust Fund (OASDI) | OASI | DI |
|---|---|---|---|
| Total Revenue | $867.0 | $753.0 | $114.0 |
| Total Outlays | $772.0 | $633.0 | $ 139.0 |
| Net Change in Assets | $95.0 | $120.0 | -$25.0 |
Source: Social Security Administration 2011 Annual Report
As the table illustrates, both the OASI and the combined Social Security Trust Fund show an increase in total assets, under this projection.
If we now take these same projections using total revenue of just 83.9% of these projections, which estimates the impact of the 2% payroll tax cut, a very different picture emerges.
| 2012 Projections $, B |
Social Security Trust Fund (OASDI) | OASI | DI |
|---|---|---|---|
| Total Revenue, with 2% payroll tax cut | $727.2 | $631.6 | $95.6 |
| Total Outlays | $772.0 | $633 | $139.0 |
| Net Change in Assets | - $44.8 | - $1.5 | - $43.4 |
Source: Social Security Administration 2011 Annual Report and Briefing.com calculations
Although the change in these results puts the Old-Age and Survivors Insurance fund at almost a neutral impact level, the large losses of the Disability Insurance Fund lead to a reduction in assets for the combined funds.
Conclusions
Most of the projections of the impact of the 2% payroll tax estimate the total impact, or drop in revenue, at about $106 billion. However, without having the details of how that estimate was derived, we calculated an estimate using an alternative approach, which produced results reasonably close to the widely used $106 billion figure.
Much of the rhetoric surrounding the debate over the 2% payroll tax cut includes statements that the loss of revenue does not negatively impact the Social Security Trust funds.
However, if you examine such political statements closely, there is rarely clarification as to whether the statement refers to just the OASI Old-Age and Survivors Insurance fund or whether it refers to the combined two funds, which is the more general usage of the term "Social Security Trust Fund."
We think the most meaningful way to examine the impact of a 2% payroll tax cut is to view the combined operations and results of the two funds that receive revenues from payroll tax.
If that viewpoint is adopted, the impact of the 2% payroll tax cut is significant. It makes the Social Security Trust Fund (combined funds) begin running at a negative rate in 2012, instead of the projected 2023 used in the 2011 Annual Report.
The Disability Insurance Fund is the weak link in this equation. In the 2011 Annual Report, the DI fund is projected to be exhausted in 2018, without consideration of a 2% payroll tax cut.
How the 2% payroll tax cut will accelerate the exhaustion date for the Disability Insurance Fund is not clear. Certainly there would be an impact, however, as the DI fund is already running at a serious deficit, which affects the entire Social Security Trust Fund.
The only conclusion to be drawn from this analysis is that the current political debate is very short-sighted. The discussion is continually routed to the political hot topics of stimulating the economy and equalizing tax burdens. Very little discussion is occurring on the potential long-term impact on the Social Security System.
There is no question in our minds: the impact of a 2% payroll tax cut weakens the financial health of the Social Security System and brings its "day of reckoning" even closer.
Whether the potential economic stimulus of a 2% payroll tax cut outweighs the weakening of the Social Security System is unclear, but that is an entirely different discussion.
Comments may be emailed to the author, Robert V. Green, at aheadofthecurve@briefing.com.
