Social Security: Temporary Payroll Tax Reduction
Released: 2012-05-07T00:00:00

Introduction

Social Security is a self-financed program that provides benefits to retired or disabled workers and their family members and to the family members of deceased workers. Social Security is financed by payroll taxes paid by covered workers and their employers. Employees and employers each pay 6.2% of covered earnings up to an annual limit; self-employed individuals pay 12.4% of net self-employment income up to an annual limit. Social Security is also credited with tax revenues from the federal income taxes paid by some beneficiaries on a portion of their benefits. In addition, Social Security receives interest income from Social Security trust fund investments. Social Security income and outgo are accounted for in two separate trust funds authorized under Title II of the Social Security Act: the Federal Old-Age and Survivors Insurance (OASI) trust fund and the Federal Disability Insurance (DI) trust fund.

In March 2010, Congress approved a temporary payroll tax exemption for employers as part of the Hiring Incentives to Restore Employment Act (HIRE Act; P.L. 111-147 ). In 2010, employers were exempt from the employer's share of the payroll tax (6.2%) if they hired an individual who had not been employed for more than 40 hours during the preceding 60-day period. The employee's share of the payroll tax was not affected. The payroll tax exemption for employers expired on December 31, 2010. The law provided general revenue transfers to the Social Security trust funds in amounts needed to protect the trust funds from a loss of payroll tax revenues due to the temporary exemption.

In December 2010, Congress approved a temporary 2 percentage point reduction in the Social Security payroll tax rate for employees and the self-employed in 2011 as part of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 ( P.L. 111-312 ). The employer's share of the payroll tax was not affected. The law provided general revenue transfers to the Social Security trust funds in amounts needed to protect the trust funds from a loss of payroll tax revenues.

In late 2011, the House and Senate considered several bills to extend and expand the payroll tax reduction in 2012. On November 28, 2011, Senator Harry Reid announced that the Senate would take up legislation to extend and expand the payroll tax reduction in 2012 ( S. 1917 ). On November 30, 2011, Senate Republicans offered an alternative proposal that would extend the payroll tax reduction for employees and the self-employed in 2012 ( S. 1931 ). On December 1, 2011, both measures failed in the Senate on procedural votes. On December 5, 2011, Senate Democrats introduced a revised proposal to extend and increase the payroll tax reduction for workers in 2012 ( S. 1944 ). On December 8, 2011, S. 1944 failed in the Senate on a procedural vote, and S. 1931 failed in the Senate a second time on a procedural vote. On December 9, 2011, House Republicans introduced a broad measure that includes a provision to extend the payroll tax reduction for workers for one year ( H.R. 3630 ). On December 13, 2011, H.R. 3630 was passed by the House by a vote of 234-193. On December 17, 2011, the Senate passed H.R. 3630 , as amended, by a vote of 89-10. H.R. 3630 , as amended, would extend the payroll tax reduction for workers for two months through the end of February 2012. On December 20, 2011, the House voted 229-193 to disagree with the Senate-passed version of H.R. 3630 and request a conference with the Senate to resolve differences between the House- and Senate-passed versions of H.R. 3630 regarding an extension of the payroll tax reduction for workers, among other provisions. On December 23, 2011, House Republicans introduced a measure ( H.R. 3765 ) to extend the payroll tax reduction for workers for two months (through February 2012). The same day, H.R. 3765 was passed by the House and the Senate and signed into law by President Obama ( P.L. 112-78 ).

On February 13, 2012, House Republicans introduced a stand-alone measure ( H.R. 4013 ) that would extend the current payroll tax reduction for workers through 2012. On February 16, 2012, House and Senate conferees agreed to file a conference report on H.R. 3630 ( H.Rept. 112-399 ), which includes an extension of the current payroll tax reduction through 2012, among other provisions. On February 17, 2012, the conference report on H.R. 3630 was agreed to in the House by a vote of 293-132 and in the Senate by a vote of 60-36. President Obama signed the measure into law on February 22, 2012 ( P.L. 112-96 ). The Social Security payroll tax for workers in effect through December 2012 is 4.2% (rather than 6.2%).

This report discusses Social Security policy considerations related to temporary payroll tax reductions. For a discussion of economic stimulus considerations related to temporary payroll tax reductions, see CRS Report R42103, Extending the Temporary Payroll Tax Reduction: A Brief Description and Economic Analysis , by [author name scrubbed] and [author name scrubbed].

How the Social Security Program Is Financed

The Social Security program is financed primarily by revenues from Federal Insurance Contributions Act (FICA) taxes and Self Employment Contributions Act (SECA) taxes. FICA taxes are paid by both employers and employees, but it is employers who remit the taxes to the U.S. Treasury. Employers remit FICA taxes on a regular basis throughout the year (for example, weekly, monthly, quarterly, or annually), depending on the employer's level of total employment taxes (Social Security, Medicare, and federal individual income tax withholding).

The FICA tax rate of 7.65% each for employers and employees has two components: 6.2% for Social Security and 1.45% for Medicare Hospital Insurance (HI). Under current law, employers and employees each pay 6.2% of covered wages, up to an annual limit, in Social Security payroll taxes. The SECA tax rate is 15.3% for self-employed individuals, with 12.4% for Social Security and 2.9% for Medicare HI. Self-employed individuals pay 12.4% of net self-employment income, up to an annual limit, in Social Security payroll taxes. One-half of the SECA taxes are allowed as a deduction for federal income tax purposes. SECA taxes are normally paid once a year as part of filing an annual individual income tax return.

In addition to Social Security payroll taxes, the Social Security program has two other sources of income. Certain Social Security beneficiaries must include a portion of Social Security benefits in taxable income for the federal income tax, and the Social Security program receives part of those tax revenues. In addition, the Social Security program receives interest from the U.S. Treasury on its investments in special U.S. government obligations.

As the Managing Trustee of the Social Security trust funds, the Secretary of the Treasury is required by law to invest Social Security revenues in interest-bearing federal government securities (special issues) held by the trust funds. The revenues exchanged for the federal government securities are deposited into the general fund of the U.S. Treasury and are indistinguishable from revenues in the general fund that come from other sources. Because the assets held by the trust funds are federal government securities, the trust fund balance represents the amount of money owed to the Social Security trust funds by the general fund of the U.S. Treasury. Funds needed to pay Social Security benefits and administrative expenses come from the redemption or sale of federal government securities held by the trust funds.

Based on the program's current financing and benefit structure, the Social Security Board of Trustees projects that Social Security expenditures will exceed tax revenues (or non-interest income) each year from 2012 to 2086 (i.e., the program will operate with annual cash-flow deficits). When interest income to the trust funds is taken into account, the trustees project that the Social Security trust funds will have a total surplus each year from 2012 to 2020 (i.e., total income—tax revenues plus interest income—will exceed Social Security expenditures). As a result, the balance in the Social Security trust funds (the amount of assets held by the trust funds in the form of federal government securities) is projected to increase each year from 2012 to 2020. Beginning in 2021, however, trust fund reserves will begin to be drawn down to help pay benefits and administrative expenses.

Over the next 75 years (2012 to 2086), the Social Security trustees project that program costs will exceed income on average by an amount equal to 2.67% of taxable payroll (stated another way, on average, costs are projected to exceed income by approximately 19%). The trustees also project that the assets held by the trust funds will be exhausted in 2033. Social Security benefits scheduled under current law can be paid in full until trust fund assets are exhausted (2033). After the trust fund reserves are exhausted, incoming Social Security receipts are projected to be sufficient to pay 75% of benefits scheduled under current law in 2033 and 73% of scheduled benefits in 2086.

Temporary Payroll Tax Reduction for Workers in 2011

As noted above, the Social Security payroll tax rate is 6.2% for employers and employees (each) and 12.4% for the self-employed. On December 17, 2010, President Obama signed into law the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 ( P.L. 111-312 ). Title VI of the law provided a temporary 2 percentage point reduction in the payroll tax rate for employees and the self-employed in 2011. The Social Security payroll tax rate in 2011 was 4.2% for employees and 10.4% for the self-employed. P.L. 111-312 made no changes to the Social Security payroll tax rate for employers (6.2%) or to the amount of annual wages and net self-employment income subject to the Social Security payroll tax ($106,800 in 2011). The reduction in the Social Security payroll tax does not affect the amount of an individual's future Social Security benefit.

The temporary reduction in the payroll tax for employees and the self-employed in 2011 was intended to provide an economic stimulus by increasing workers' take-home pay. For example, the annual Social Security withholding for a worker earning the average wage in 2011 (an estimated $44,687) was lower by about $894. The annual Social Security withholding for a worker earning the maximum taxable wage ($106,800 in 2011) was lower by $2,136.

To protect the Social Security trust funds from a loss of payroll tax revenues resulting from the temporary reduction in the payroll tax rate for employees and the self-employed, P.L. 111-312 appropriated to the Social Security trust funds amounts equal to the reduction in payroll tax revenues to the Treasury. The law specified that these appropriated amounts "shall be transferred from the general fund at such times and in such manner as to replicate to the extent possible the transfers which would have occurred to such Trust Fund had such amendments not been enacted." In August 2011, the Congressional Budget Office (CBO) estimated that general revenue transfers to the Social Security trust funds as a result of the temporary payroll tax reduction in 2011 would total $111 billion.

Senate Democratic Proposal to Extend and Expand the Payroll Tax Reduction in 2012 (S. 1917)

On November 28, 2011, Senator Harry Reid announced that the Senate would take up legislation to extend and expand the Social Security payroll tax reduction in 2012 ( S. 1917 , the Middle Class Tax Cut Act of 2011, introduced by Senator Robert Casey). S. 1917 would provide a 3.1 percentage point reduction in the payroll tax for workers in 2012 (the worker's share of the payroll tax would be reduced from 6.2% to 3.1%). In addition, the measure would provide a 3.1 percentage point reduction in the payroll tax for employers (from 6.2% to 3.1%) on the first $5 million of taxable payroll for 2012.

The measure also would eliminate the Social Security payroll tax for employers on the first $12.5 million of increased wages paid by the employer for the fourth quarter of 2011, and on the first $50 million of increased wages paid by the employer for 2012 (i.e., increased wages attributed to new hires or higher wages paid to current workers).

S. 1917 would provide general revenue transfers to the Social Security trust funds to make up for the loss of payroll tax revenues.

A preliminary estimate by the Joint Committee on Taxation shows that the payroll tax provisions in S. 1917 would cost $265 billion. To offset the cost of the measure, S. 1917 would impose a 3.25% surtax on modified adjusted gross income in excess of $1 million for single filers and married couples filing jointly, effective for taxable years beginning after December 31, 2012.

On December 1, 2011, S. 1917 failed in the Senate on a 51-49 procedural vote.

Senate Republican Proposal to Extend the Payroll Tax Reduction in 2012 (S. 1931)

On November 30, 2011, Senator Dean Heller introduced legislation ( S. 1931 , the Temporary Tax Holiday and Government Reduction Act) to extend the temporary 2 percentage point reduction in the Social Security payroll tax for workers, set to expire at the end of calendar year 2011, in 2012. S. 1931 , offered as an alternative to the Senate Democratic proposal, would not provide a payroll tax reduction for employers. The measure would provide general revenue transfers to the Social Security trust funds to make up for the loss of payroll tax revenues.

Among other provisions, S. 1931 would offset the cost by extending the current federal employee pay freeze for an additional three years and reducing the size of the federal workforce. The measure would effectively eliminate unemployment compensation for certain individuals based on income; make certain individuals ineligible for benefits under the Supplemental Nutrition Assistance Program (formerly known as food stamps) based on income; and require certain individuals, based on income, to pay higher Medicare premiums compared with current law.

On December 1, 2011, S. 1931 failed in the Senate on a 20-78 procedural vote. S. 1931 failed in the Senate a second time by a 22-76 procedural vote on December 8, 2011.

Revised Senate Democratic Proposal to Extend and Increase the Payroll Tax Reduction for Workers in 2012 (S. 1944)

On December 5, 2011, Senator Robert Casey introduced a revised Senate Democratic proposal to extend and increase the Social Security payroll tax reduction for workers in 2012 ( S. 1944 , the Middle Class Tax Cut Act of 2011). Among other provisions, S. 1944 would provide a 3.1 percentage point reduction in the Social Security payroll tax for workers in 2012 (the worker's share of the payroll tax would be reduced from 6.2% to 3.1%). The measure would not provide a payroll tax reduction for employers. S. 1944 would provide general revenue transfers to the Social Security trust funds to make up for the loss of payroll tax revenues.

To offset the cost of the measure, S. 1944 would impose a temporary 1.9% surtax on modified adjusted gross income in excess of $1 million for single filers and married couples filing jointly, effective for taxable years beginning after 2012 and before 2022. In addition, the measure would increase the fees that Fannie Mae and Freddie Mac charge mortgage lenders to guarantee repayment of new mortgage loans. S. 1944 would effectively eliminate unemployment compensation for certain individuals based on income and make certain individuals ineligible for benefits under the Supplemental Nutrition Assistance Program (formerly known as food stamps) based on income.

On December 8, 2011, S. 1944 failed in the Senate on a 50-48 procedural vote.

House Republican Proposal to Extend the Social Security Payroll Tax Reduction for Workers in 2012 (H.R. 3630)

On December 9, 2011, Representative Dave Camp introduced H.R. 3630 , the Middle Class Tax Relief and Job Creation Act of 2011. Among other provisions, the broad (369-page) measure would extend for one year the 2 percentage point reduction in the Social Security payroll tax for workers. The measure would not provide a payroll tax reduction for employers. H.R. 3630 would provide general revenue transfers to the Social Security trust funds to make up for the loss of payroll tax revenues.

Among other provisions, H.R. 3630 would offset the cost of the bill by extending the current pay freeze for federal employees and making changes to civilian federal pension benefits. The measure would effectively eliminate unemployment compensation for certain individuals based on income; make certain individuals ineligible for benefits under the Supplemental Nutrition Assistance Program (formerly known as food stamps) based on income; and require certain individuals, based on income, to pay higher Medicare premiums compared with current law.

On December 13, 2011, H.R. 3630 was passed by the House by a vote of 234-193.

Senate Proposal to Extend for Two Months the Social Security Payroll Tax Reduction for Workers (H.R. 3630, As Amended)

On December 17, 2011, the Senate passed H.R. 3630 , with an amendment in the nature of a substitute ( S.Amdt. 1465 ), by a vote of 89-10. Among other provisions, the Senate-passed version of H.R. 3630 (renamed the Temporary Payroll Tax Cut Continuation Act of 2011) would extend the payroll tax reduction for workers for two months (i.e., for January and February 2012). Under H.R. 3630 , as amended, the reduced 4.2% payroll tax rate for workers would apply to the first $18,350 of covered wages (an amount equal to two-twelfths of the 2012 taxable wage base of $110,100).

On December 20, 2011, the House voted 229-193 to disagree with the Senate-passed version of H.R. 3630 and request a conference with the Senate to resolve differences between the House- and Senate-passed versions of H.R. 3630 regarding an extension of the payroll tax reduction for workers.

House and Senate Agreement on a Two-Month Extension of the Payroll Tax Reduction for Workers (H.R. 3765, P.L. 112-78)

On December 23, 2011, Representative Dave Camp introduced H.R. 3765 , the Temporary Payroll Tax Cut Continuation Act of 2011. Among other provisions, the measure extends the 2 percentage point reduction in the Social Security payroll tax for workers for two months (i.e., through February 29, 2012). The reduced payroll tax rate (4.2%) applies to the first $18,350 of covered wages (an amount equal to two-twelfths of the 2012 taxable wage base of $110,100).

On December 23, 2011, H.R. 3765 was passed by the House and the Senate and signed into law by President Obama ( P.L. 112-78 ).

House Republican Proposal to Extend the Payroll Tax Reduction for Workers Through 2012 (H.R. 4013)

On February 13, 2012, Representative Wally Herger introduced H.R. 4013 , the Temporary Payroll Tax Cut Continuation Act of 2012. The measure would extend the 2 percentage point reduction in the Social Security payroll tax for workers through the end of calendar year 2012 (i.e., from March through December 2012). The measure would provide general revenue transfers to the Social Security trust funds to make up for the loss of payroll tax revenues. H.R. 4013 does not include provisions to offset the cost of the measure.

Conference Agreement on H.R. 3630 (P.L. 112-96)

On February 16, 2012, the conference committee appointed to resolve differences between the House- and Senate-passed versions of H.R. 3630 (discussed above) agreed to file a conference report on the measure ( H.Rept. 112-399 ). On February 17, 2012, the House agreed to the conference report on H.R. 3630 by a vote of 293-132. The same day, the Senate agreed to the conference report on H.R. 3630 by a vote of 60-36. President Obama signed the measure into law on February 22, 2012 ( P.L. 112-96 ).

Among other provisions, P.L. 112-96 extends the current 2 percentage point reduction in the Social Security payroll tax for workers (previously scheduled to expire at the end of February 2012) through the end of calendar year 2012. The Social Security payroll tax for workers in effect through December 2012 is 4.2% (rather than 6.2%). It provides general revenue transfers to the Social Security trust funds to make up for the loss of payroll tax revenues.

The overall cost of P.L. 112-96 is partially offset by increasing the employee pension contribution for federal employees entering service after December 31, 2012, among other provisions.

For documents related to P.L. 112-96 , the Middle Class Tax Relief and Job Creation Act of 2012, see the following:

Conference Report on H.R. 3630 ( H.Rept. 112-399 ), February 16, 2012, at http://www.gpo.gov/fdsys/pkg/CRPT-112hrpt399/pdf/CRPT-112hrpt399.pdf

Congressional Budget Office, Letter to the Honorable Dave Camp, February 16, 2012, at http://www.cbo.gov/ftpdocs/127xx/doc12764/hr3630.pdf

Social Security Policy Considerations

The temporary reduction in the payroll tax for employees and the self-employed has drawn mixed reactions from policymakers. The following section presents key policy considerations raised by opponents and supporters of the temporary payroll tax reduction.

Views Among Opponents

Despite the general revenue transfers to protect the trust funds from a loss of payroll tax revenues, some observers have expressed concern about the potential impact of the temporary reduction in the payroll tax for employees and the self-employed on Social Security's long-term finances. These observers point out that, although the payroll tax reduction is temporary, the possibility remains that Congress could continue to extend the payroll tax reduction or make the payroll tax reduction permanent in response to political or other pressures without providing transfers from general revenues. In addition, restoring the 2 percentage points of the employee's share of the payroll tax (from 4.2% to 6.2%) could be viewed by the public as a 50% increase in Social Security payroll taxes.

Opponents maintain that the general revenue transfers to the Social Security trust funds introduce an element of general revenue financing to the Social Security program, signaling a departure from the self-financing mechanism that has been in place since the program's enactment in the 1930s. They believe that, without a dedicated revenue source, the future of the program could be in jeopardy if, like other federal programs, Social Security must rely on general revenues for part of its funding. Moreover, they point out that using general revenues to partially fund benefits breaks the traditional link between payroll tax contributions and benefits, weakening the fundamental earned-right nature of the program which in turn could affect public support for the program. Finally, some argue that using general revenues to partially fund Social Security benefits is unfair because not all taxpayers participate in the Social Security system.

Some observers believe that other policy options, such as an extension of the Making Work Pay (MWP) refundable tax credit, would be more effective as an economic stimulus measure than a temporary reduction in the employees' share of the payroll tax. The MWP tax credit was authorized by the American Recovery and Reinvestment Act of 2009 (ARRA; P.L. 111-5 ) and expired on December 31, 2010. It provided workers with a federal income tax credit of 6.2% of wages, up to a maximum credit of $400 ($800 for married couples filing jointly), in tax years 2009 and 2010. The MWP tax credit was phased out for workers with incomes above $75,000 ($150,000 for married couples filing jointly). It was implemented during the tax year by lowering the amount of federal income taxes withheld from workers' paychecks.

Some observers favor the MWP tax credit over a reduction in the Social Security payroll tax because it was available to all workers (not just those covered by Social Security). Moreover, the MWP tax credit was more favorable to workers earning less than $20,000, compared to the payroll tax reduction. For a worker earning $20,000, the value of the MWP tax credit and the payroll tax reduction is the same ($400). At earnings levels above $20,000, the value of the payroll tax reduction is relatively greater. At earnings levels below $20,000, the value of the MWP tax credit is relatively greater.

Because the refundable MWP tax credit was more generous to lower-wage workers compared to the payroll tax reduction (which provides an increasingly larger dollar benefit for workers with higher earnings), and lower-wage earners are believed to be more likely to spend the additional take-home pay compared with middle- and higher-wage earners, the MWP tax credit is considered by some to be a more effective economic stimulus measure. As a result, some observers recommend adding a "hold harmless" provision for lower-wage workers so that these workers would be no worse off under the payroll tax reduction compared with the MWP tax credit.

Views Among Supporters

Some observers support the temporary reduction in the Social Security payroll tax on the basis that it will stimulate economic recovery and create jobs at a time when the United States continues to experience high rates of unemployment. They maintain that the immediate increase in take-home pay will spur additional consumer spending, increasing the demand for products and services, which in turn will increase production and employment.

A temporary reduction in the Social Security payroll tax is not without precedent. In 2010, Congress approved a temporary exemption from the payroll tax for employers who hired certain unemployed persons, as part of the HIRE Act of 2010 ( P.L. 111-147 ). Temporarily reducing Social Security payroll taxes is a policy option that has been advanced in various forms by recent deficit reduction commissions, among others, as an effective way to stimulate economic growth and job creation consistent with long-term fiscal discipline.

In testimony before the Senate Budget Committee in September 2010 on the potential impact of various fiscal policy options on the economy, CBO Director Douglas W. Elmendorf stated:

A temporary reduction in payroll taxes—especially in the share of taxes paid by employers—would also have a significant positive short-term effect on the economy. This approach would boost output and employment both by increasing demand for goods and services and by providing an incentive for additional hiring.

CBO estimated that reducing Social Security payroll taxes for employees would raise output cumulatively over a five-year period by $0.30 to $0.90 per dollar of total budgetary cost. In comparison, CBO estimated that reducing Social Security payroll taxes for employers would have a somewhat larger effect, raising output by $0.40 to $1.20 per dollar of total budgetary cost.

In November 2010, the Bipartisan Policy Center's deficit reduction commission co-chaired by former Senator Pete Domenici and Dr. Alice Rivlin recommended a one-year suspension of the Social Security payroll tax for employers and employees. The commission recommended that employers and employees be exempt from the 12.4% payroll tax in 2011, and that the Social Security trust funds be reimbursed in full from general revenues. The commission stated that the proposal would cost an estimated $650 billion and would create between 2.5 million and 7 million new jobs (based on CBO assumptions).

In December 2010, the National Commission on Fiscal Responsibility and Reform established by President Obama recommended a "temporary suspension of one side of the Social Security payroll tax, financed by transfers from general revenue." The commission stated that the proposal would cost an estimated $50 billion to $100 billion in lost revenues, depending on the design, and that CBO found it would result in "significant short-term economic growth and job creation."