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Don't Cut the Payroll Tax, Unless...

While most economic indicators remain strong, with unemployment at historic lows and personal incomes rising, some troubling indicators have begun to appear: most notably a decline in business orders and an inverted yield curve. It makes sense for the Trump administration to continue talking up the current economy while also considering actions to keep the economy going, as appears to be happening.

News reports suggest that several ideas are being considered, including a Treasury Department indexing of capital gains to inflation, which is a tremendous idea regardless of how or why it’s done. But another idea apparently being considered is a temporary cut in the payroll taxes collected to fund the Social Security and Medicare programs.

The idea that a payroll tax cut would stimulate economic growth is flawed, because it is based on the notion that growth is driven by consumption. “Put more money in people’s pockets” is the idea, and they will spend more, stimulating the economy.

Except that it won’t. Economic growth is driven by saving and investment, not by consumption. When businesses have easy access to capital and are reasonably optimistic about the future, they take risks and invest in new plants, equipment and employees. That’s economic growth.

Artificially juicing consumption isn’t a particularly powerful way to stimulate economic growth, as recent history has shown, and as IPI research found years ago. In fact, IPI’s work showed that a payroll tax cut is the least potent tool to drive economic growth. Interest rate policies and capital gains tax reductions have a much more beneficial impact on the economy than a payroll tax cut.

However... there is one possible silver lining to a payroll tax cut. A temporary cut in payroll taxes creates a unique opportunity to implement one of our favorite pro-growth policy ideas—personal retirement accounts.

Let’s say there is a temporary 3 percentage point payroll tax cut. When the temporary payroll tax cut expires, those 3 percentage points wouldn’t  just go back the federal government. Rather, the money would be redirected into personal retirement accounts for every worker (we have called them “Trump Retirement Accounts”), which the feds had set up in the meantime.  

The new personal retirement accounts would represent enormous new investment, which should have a much more positive impact on economic growth than stimulating more spending.

But personal retirement accounts could also eventually offset most of the failing Social Security system’s future liabilities to workers and thus represent a much-needed step to begin addressing our entitlements crisis.

Add Trump Retirement Accounts to a temporary payroll tax cut, and now we’re talking.