The $10-Billion-a-Month 'Holiday' this Country Can’t Afford

Faced with our record $15 trillion federal deficit and last year’s embarrassing downgrade of Treasury securities, guess what politicians have decided to do? Pile on more debt!

Yes, folks, it’s true. Only they’re not calling it that. Instead, it comes wrapped up with a pretty bow and is being packaged as a “Tax Holiday.” I’m talking about the “temporary” reduction in Social Security tax enacted last year to supposedly stimulate the economy (What? You didn’t notice?), extended in late December through this month, and just last week extended through the remainder of this year.

Perfect! Takes us right through the November election.

Here’s the spin espoused by both Democrats and Republicans: Reducing the 6.2% tax that workers pay toward Social Security to 4.2% puts more money in consumers’ pockets(1), allows them to spend more and  stimulate the economy. That, in turn, leads to the creation of more jobs. (2)

Here’s what they’re not telling us: this little election year “gift” is adding $10 billion per month to our national debt! That’s $120 billion a year! How come? Because in order to not accelerate the deterioration of Social Security’s finances, the Treasury is required to make up the money not collected via payroll taxes. And since there’s not a lot of extra cash sitting around Washington, D.C., these days, that means the government has to issue more debt.

If this sounds like bone-headed economics, you’re right. A recent study of 34 industrialized countries by The Tax Foundation’s Will McBride confirms that “payroll tax cuts have no impact on long-term economic growth.” In fact, the payroll tax rate in the U.S. is already the lowest among the OECD countries! (Find the complete report here)

According to McBride, “Since 2000, our economy has grown at a rate that is well below the average for similar economies.” If we’re serious about turning this around, he says the simple- albeit politically and socially unpopular- solution is: reduce the taxes that American corporations pay, which is currently the second-highest in the world. Moreover, on April 1, when a cut in Japan’s corporate tax rate takes effect, the United States will officially move into first place.

“The data all shows that corporate income tax is the most damaging to economic growth,” says McBride, an economist. That’s because the goal of all businesses is to make a profit, which is the income they have left over after paying expenses, including taxes. “There’s two things they can spend this on,” explains McBride, “labor or capital.” The two are interrelated.

Let’s start with labor. If companies are able to send less money to the government, they’ll have more left to hire more workers, to both produce and continuously improve upon the products and services they offer. Think about where Apple (NASDAQ:AAPL)- and consumers worldwide- would be today if Steve Jobs had simply been content with the first Macintosh computer his company produced back in 1984. Eventually someone might have come up with innovations like the iPod, iPhone, iPad, but who knows when? Thankfully, Jobs continued to hire more really smart people, challenged them to innovate and in doing so, pulled an entire global industry along the learning curve with him.

“Capital” refers to non-human resources such as factories and equipment- tractors, machinery, new research labs, cranes, training- anything that enables workers to be more productive, that is, to turn out better products for less cost. “Productivity leads to higher living standards,” explains McBride. For example, say you have a worker who can make 15 widgets/hour. The next year you provide her with better equipment and she makes 25 widgets/hour. Now she’s more productive. “When your labor output is worth more, you get paid more,” says McBride. “This is the essence of higher living standards.”

It doesn’t happen over night, of course, to the dismay of politicians, who face re-election in 1, 2, or 4-year cycles. But capital accumulation- the steady introduction of better equipment and training, has a cumulative effect. “We build upon the capital investments of the past,” says McBride. “The computers of the 1980s were the foundation for the IPad today. New drugs are built on previous patents.”

He warns, “If we fail to create the conditions for [business] investment today through our tax code and regulatory environment, we’re going to lose out on future economic growth.” To put another way, the United States is going to lose its technological and economic edge.

It’s already slipping. China is the obvious example.  But it’s not the fastest-growing economy among OECD countries. That honor goes to Slovakia. Rounding out the top 3 are two other Eastern European countries: Poland and the Czech Republic. All three have below-average corporate tax rates compared to other countries in the OECD.

Ah, but how can we possibly afford to lower taxes on mean old corporations when our national debt is at a record-high? “That’s not a good argument,” says McBride. “Corporate taxes make up 10% or less of federal revenue.” Moreover, it’s not a reliable source of income for the government because it has large variations. “From 2007 to 2009 corporate taxes fell by nearly half due to the recession.” In fact, personal income taxes and payroll taxes make up the lion’s share of revenue collected by the federal government.

What most people fail to understand, says McBride, is that the tax a business pays is actually an indirect tax on its employees. “Seventy percent of it is borne by workers in the form of lower wages.” In other words, your employer could afford to pay you more if it didn’t have to fork over so much to Uncle Sam.

Of course, in the acrimonious atmosphere of this election year, no politician interested in being elected to office will ever propose reducing the corporate income tax. That might be smart economics, but the fact, is corporations can’t vote. On the other hand, anyone who suggests restoring the worker-paid portion of the payroll tax rate to 6.2% is going to be accused of “raising” taxes. Ask the first President Bush how well that goes over with the electorate.

Though it’s clearly a pipe dream, consider that instead of spending $120 billion to reduce the payroll tax this year, we upped the amount to $200 billion and temporarily eliminated the corporate income tax. The result, McBride predicts, would be “an unprecedented economic boom.” That, of course, would increase business profits, lead to more hiring and productivity and, ultimately, generate more revenue to the federal government. Oh, and help America re-gain its economic leadership.

Alas, that is not how bone-headed, election-driven politicians think. Whatever happened to the idea of doing what’s best for our country?

1. In case you haven’t noticed the effects of the “tax holiday” it might be because you are: 1) retired, or 2) unemployed. You only get the benefit of this tax break if you have a paycheck coming in. For the average worker, this amounts to less than $20 every two weeks.

2. There has been no change in the payroll tax paid by employers. It is still 6.2%.

Ms. Buckner is a Retirement and Financial Planning Specialist and an instructor in Franklin Templeton Investments' global Academy. The views expressed in this article are only those of Ms. Buckner or the individual commentator identified therein, and are not necessarily the views of Franklin Templeton Investments, which has not reviewed, and is not responsible for, the content. 

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