The economic fallout from COVID-19 is depriving Social Security and Medicare of much-needed revenue, and now a series of executive orders might add to their financial burdens … or not. But why? The answer lies in how these programs are funded.
If you’ve been to a Free the Facts event, you already know that our country’s entitlement programs operate on a pay-as-you-go system. Payroll taxes from current workers and their employers pay for the benefits collected by current retirees.
If you’ve ever earned a paycheck, then you’ve seen this system in action. Every pay period, your employer deducts 7.65% of your earnings (6.2% for Social Security and 1.45% for Medicare ss1), and sends it to the IRS on your behalf. This is what’s known as the “employee share” of payroll taxes.
Your employer then matches the tax you pay and sends a contribution equal to 7.65% of your earnings to the IRS. This is the “employer share” of payroll taxes.
Between you and your employer, that’s a total of 15.3% in payroll taxes going to Social Security and Medicare.
So what was announced?
Earlier this year Congress passed the CARES Act, which allowed employers to delay paying the “employer share” of Social Security taxes through December 31, 2020. Employers still have to pay the tax eventually, but the hope was that providing flexibility in when they paid would help employers deal with the financial strain caused by the pandemic.
In August, President Trump issued an executive order offering employees the same flexibility. Under the order, workers making $104,000 per year or less can defer paying the “employee share” of their payroll taxes from September 1st to December 31st. In theory, workers could delay paying their 6.2% Social Security payroll tax and get a larger paycheck now.
To put that in perspective: Let’s say you make $50,000 a year. Under this executive order, your after-tax income could temporarily rise by $1,023 over four months.
Sounds pretty good. Are there any downsides?
Yes, remember we said in theory. The big question is whether the relief offered under the order will become a reality for employees.
First, remember that employers are the ones responsible for withholding the “employee share” of payroll taxes and sending it to the IRS. In order for a person to take advantage of the flexibility offered by the president’s order, their employer has to be willing to implement a delay.
Second, just like employers under the CARES Act, employees can only defer paying their share of the payroll tax. Under the order, they would still have to pay the full amount they owe come January.
In a sense, workers making under $104,000 per year would get an interest-free loan from the federal government. But the loan would need to be repaid early next year. And that’s only if their employer is willing to wait and collect the deferred taxes later on.
Why defer payroll taxes instead of forgiving them altogether?
The President doesn’t have the constitutional authority to forgive lost tax revenue. That counts as “spending,” and only Congress can approve that.
President Trump has promised that if he’s reelected, he will work with Congress to forgive the deferred payroll taxes owed by workers. But that’s a big “if,” and since businesses are legally responsible for withholding payroll taxes, many may be reluctant to stop collecting money they will ultimately be responsible for.
If payroll taxes pay for entitlement programs, then what’s going to happen to Social Security?
That turns out to be a pretty complicated question! Check out our analysis of five possible scenarios.
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