The “payroll tax” is actually two separate taxes paid by every American who earns income from wages. The larger tax is 12.4 percent of earnings up to an annual maximum of $132,900. This tax is split between the employer and employee and pays for Social Security’s retirement and disability insurance programs. The smaller tax is 2.9 percent, also split between employer and employee, and pays for Medicare’s hospital insurance program (Part A). That tax is paid on all employee earnings, and an additional 0.9 percent Medicare tax is levied on all earnings above $200,000.
The political advantage to cutting the payroll tax is obvious: Every working American pays it, so every working American would get a tax cut. Indeed, millions of Americans pay more in payroll taxes than they do in income taxes because of that tax system’s generous deductions and child tax credits. This is especially true for the working-class voters who are crucial to Trump’s chances of winning Wisconsin, Michigan, Iowa and Pennsylvania. They will get much more cash back from a payroll tax cut than they did from the 2017 income tax cut.
The economic advantage is also clear: Cutting the payroll tax would likely prop up consumer demand. If Trump continues to levy tariffs on Chinese goods, a payroll tax cut would offset much of the ensuing price increases. This can help keep the economy afloat during the protracted trade negotiations.
Cutting the payroll tax would help struggling businesses, too. If the administration cut the payroll tax by 2 percent and split the cut between employers and employees, business owners would get a cash influx. For retailers paying higher prices for imported goods or manufacturers adjusting to lower levels of demand for their wares, this represents an immediate, ongoing cash subsidy that can help them balance their books and keep them from laying off workers.
There are also ways to offset some of the tax cuts’ cost to alleviate concerns about the deficit. Well-to-do seniors pay nearly the same amount in Medicare’s monthly premiums as do the poorest. Increasing their Medicare premiums would recoup some tax money while putting the Medicare program on a fairer and sounder long-term footing. The administration could also steal some of the Democrats’ populist thunder by eliminating the income tax rate cut passed in 2017 or by making families earning more than $450,000 annually pay taxes on their employer-paid health insurance premiums. Either measure would recoup a large share of the revenue loss from the payroll tax cut.
Alternative tax cuts would have neither the political nor the economic impact of payroll tax cuts. One other potential approach — indexing the cost basis used to calculate capital-gains taxes to inflation — would fail both tests.
The economic effect of indexing would mainly flow to wealthier households and entities, creating a negative political impact. Working-class voters shifted to Trump in 2016 in part because they resented the way the well-to-do always seemed to get bailed out in tough times while they bore the full brunt of downturns. Capital-gains tax indexation would show these voters that Trump is no different from the “Republicrats” they wanted to throw out. And without their overwhelming backing, Trump has no chance of winning reelection.
The economic effect would also be attenuated. Cutting capital-gains taxes would at best spur investment as owners of stock and property sell assets to reap the lower taxes and theoretically reinvest it in more economically useful ways. But that effect would take time to be felt, if it actually occurred. And many reports suggest businesses are holding back on investment, in part because of the ongoing trade conflict with China. Cutting taxes on business investment at a time when business investment is lower for reasons unrelated to taxes might simply pad corporate profits. That would be good for the stock market but wouldn’t forestall a recession.
Trump innately understands what his economic advisers often don’t: He was elected to change the U.S. economy to provide more protection and wealth directly to working- and middle-class voters. If these voters wanted more supply-side stimulus, they would have voted for Mitt Romney in 2012. These people want someone who cares directly about them, not someone who purportedly cares about them but actually cares most about the business and entrepreneurial class.
The president is often at his best when he follows his gut and tells his advisers to make things happen. If he decides the economy needs a fiscal stimulus, he should go for the payroll tax cut and tell his economic team to get on board.