Trump’s Payroll Tax Deferral Is Bad Economics

“It was worse than a crime, it was a blunder” – Joseph Fouché, French Imperial Minister of Police, 1804

It takes hard work and creativity to develop a tax cut that I would oppose. Somehow, Trump pulled it off – again – with his payroll tax deferral that only lasts three months and only applies to workers making less than $104,000 a year.

There are more than a few conservatives who are upset over Trump’s unconstitutional power grab. While I agree with them wholeheartedly, this post will address the economic effects of the policy. They’re terrible.

In order to determine how beneficial a tax change is, I rely on the four metrics developed by the Mercatus Center (emphasis in original):

Washington has research and evidence to help identify and define the principles and goals key to a successful revenue system. Academic research suggests it must be:

Simple. The complexity of the tax system makes it difficult and costly to comply with and encourages tax avoidance. A simpler and more transparent tax code promotes compliance and increased revenues.

Efficient. The tax code impedes economic growth by distorting market decisions in areas such as work, saving, investment, and job creation. An efficient tax system provides sufficient revenue to fund the government’s essential services with minimal distortion of market behavior.

Equitable. Americans of all income levels and personal situations believe the tax code is unfair. This perception is largely fueled by the code’s “loopholes”—or provisions intended to benefit or penalize select individuals and groups. “Tax fairness” should reduce or eliminate provisions that favor one group or economic activity over another, especially among equal-income earners.

Predictable. Tax certainty inspires economic growth and investment and also enhances competitiveness. An environment conducive to growth requires a tax code that provides both near- and long-term predictability.

Trump’s executive order on payroll tax deferral fails on all four metrics.

Let’s start with simplicity and efficiency. Section 2, paragraph (a) fails on both counts:

The deferral shall be made available with respect to any employee the amount of whose wages or compensation, as applicable, payable during any bi-weekly pay period generally is less than $4,000, calculated on a pre-tax basis, or the equivalent amount with respect to other pay periods.

The cap of $104,ooo a year will make the tax code more complex, not less. Making matters worse, the language in the order imposes the entire tax on workers making over $104,000. This creates a “cliff-edge” tax of more than $2,000 on employees (and a similar payroll cost increase for the firms employing them). This will turbocharge the very tax avoidances that weaken economic growth. It will also distort incentives away from higher labor productivity (because they lead to higher wages).

In other words, the executive order makes the tax code less simple and less efficient. It also makes the code less equitable, as earners just over $104,000 in salary will earn less after taxes than those making between $102,000 and $103,999.

That leaves predictability, where things aren’t any better. Here’s Section 2 and 4:

The Secretary of the Treasury is hereby directed to use his authority pursuant to 26 U.S.C. 7508A to defer the withholding, deposit, and payment of the tax imposed by 26 U.S.C. 3101(a), and so much of the tax imposed by 26 U.S.C. 3201 as is attributable to the rate in effect under 26 U.S.C. 3101(a), on wages or compensation, as applicable, paid during the period of September 1, 2020, through December 31, 2020, subject to the following conditions…

Sec4.  Tax Forgiveness.  The Secretary of the Treasury shall explore avenues, including legislation, to eliminate the obligation to pay the taxes deferred pursuant to the implementation of this memorandum.

In other words, the payroll tax is only deferred for three months, while no one yet knows if or how they will pay it back. That kind of uncertainty is the nearly complete opposite of predictable.

In short, this executive order adds more complexity to the tax code, more uncertainty about future taxes, and more inefficiencies by the discouragement of increasing labor productivity. It will do little to nothing for the economy at the moment, and will in fact damage it in the medium term. The only hope we have is that a new Administration reverses this and prevents long term damage.

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