Give Labor a Break

In recent decades, a major focus of federal tax policy has been to boost savings and investment, largely by sheltering capital from taxes. Today, investment is strong, especially in high-tech equipment, and the stock market is at an all-time high.

Now may be a good time to encourage more investment in human capital by easing back on the payroll tax. Today's tax code typically levies a higher tax on investments in human capital, such as education and training, than it does on investments in physical capital, like computers and office buildings.

The main reason is that in addition to an income tax workers are faced with a large payroll tax, mainly for Social Security. The total payroll tax now stands at more than 15%--up from nearly 10% two decades ago--on wages up to slightly more than $65,000. Technically, half the tax is paid by workers and half by employers. But almost all economists agree that the employer share is paid by workers through lower wages.

A high payroll tax means that lower-and middle-income workers who acquire more training, skills, and education end up paying a very high marginal tax rate on their increased wages. The payroll tax also places a heavy burden on the entrepreneurial economy--small business and the self-employed - because the tax must be paid regardless of profitability.

The high payroll tax bothers many economists, liberal and conservative alike. But, they point out, there is a big obstacle to nudging it lower - the bill for Social Security. The political obstacles are daunting, but there are ways to make up any funding shortfall. One possibility is to tap general revenues. Another is to use any savings from adjusting the consumer price index downward to offset a payroll tax cut.

In the long run, however, Social Security projections show that what truly matters when it comes to the system's fiscal health is the economy's growth rate. In our high-tech, global economy, the road to wealth lies in increasing worker knowledge and skill.

Of course, there's no guarantee that workers will spend the money they save from a lower payroll tax on more education or that entrepreneurs will create more jobs. Some of the money will end up at the mall. Still, lowering the payroll tax would reduce one major bias in the tax code against human capital investment. Give labor a break.


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