Payroll Taxes Deferral
By now, everyone has heard about the payroll tax deferral ordered by President Trump. This is a deferral, and not abatement of the tax–at least, for now anyway. Only Congress can authorize the forgiveness of the tax. Without debating the virtue of this move, I want to address some of the issues associated with it from a more theoretical point of view.
The Social Security System. I was a little surprised to read one critic saying the deferral is a slippery slope toward the weakening of the entire Social Security System. Seriously? I teach the students in my federal income tax class there is no Social Security fund. The entire system is “pay as you go” already. If you believe there is a Social Security fund you might as well believe in….I have to be careful here. I have young grandchildren. But you get what I mean. What is really going on? Richard Thaler, the Nobel Prize winning economist invented the term mental accounting. It seems our minds budget like we are all still using the accordion files of old. You remember them. You would “cash your paycheck”—I know there is a whole generation out there who doesn’t know what that means—and then put so much money in the rent pocket, so much in the electric bill pocket, etc. The dollars are fungible, but our minds keep track of things by using these compartments. It appears some pundits have done this with payroll taxes. They have put the Social Security taxes in the Social Security Fund pocket of the accordion folder.
Implementation Problems. Those of you familiar with the operation of large organizations know they don’t handle one-off transactions very well. There is a much greater chance of processing errors dealing with them. Large bureaucracies need programmed decision-making, policies and procedures to function well. They are uniquely organized to provide the same outcome for repetitive problems. Not so much with novel situations though, such as deferring and later potentially collecting the payroll tax. This will require a new solution where none currently exists. Look at the problems the IRS had in delivering the first stimulus checks for the current pandemic. This is not to be critical of the IRS and their fine employees. They moved mountains to get money out to the American people. The problem was the new process resulted in many more errors than the IRS normally commits. Daniel Kahneman, another Nobel Prize winner, coined the term availability heuristic to describe how easily remembered information impacts our judgement. In this case, we remember the lurid stories of IRS processing errors and not the hundreds of millions of stimulus checks successfully distributed. Sadly, this new challenge for the IRS will result in a large number of snafus again, and an increased perception the IRS is inept.
Go Ahead. Try and Collect It! President Trump has long advocated a cut in payroll taxes. Without looking at the merits of such a tax cut, the deferral of payroll taxes could have unanticipated consequences. The endowment effect, another behavioral economics concept, states people hate to give up something they believe they already own. Tax accountants know clients HATE owing money at the end of the year. They feel as if something they own is being taken away from them. The IRS withholding tables are set to insure almost everyone will get a refund at the end of the year. The first stimulus checks were sent to those who had received electronic refunds (the majority of taxpayers). This was an existing outlet the IRS knew would reach the greatest amount of people in the quickest time. It will be very interesting to see how the IRS will attempt to collect the payroll tax if and when that happens. The IRS, Congress, and the President know about the endowment effect. I believe the President enacted this deferral to press Congress into a temporary payroll tax cut. The wailing and gnashing of teeth will be heard far and wide if the government tries to collect this tax next year. It will be interesting to see how the political process deals with this looming problem.