The payroll tax cut

Recently the federal government renewed the reduction of the payroll tax cut. What is the payroll tax? How will the reduction help the economy? And are there any downsides to the cut? N.C. State University economist Mike Walden answers.

“Well …, the payroll tax is the tax that funds Social Security and Medicare. It’s paid by all workers. And what the federal government has done actually for the last couple of years is to reduce it by 2 percentage points, which translates into about $40 per week for the average worker. This is designed to put more money in people’s pockets.

“Hopefully, people will spend that money. That will generate new business for businesses, new jobs, et cetera. So this is sort of like a tax stimulus.

“The downside, though, is because the payroll tax does fund Social Security and Medicare, this means less money is going into the savings for those future expenditures. And we already know, we’ve known for a long time that down the road — and down the road is maybe only 15 or 20 years — particularly Social Security is going to run out of money. And Medicare already is using general taxpayer money. In other words, it already spends more than what’s allotted to it from the payroll tax cut.

“So this is a typical example of something that’s done for a short-run benefit that is trying to boost spending — boost consumers — in the short run. But it is going to have a long-run cost in terms of reducing the solvency of both Social Security and Medicare.”