Yahoo U: Trump’s Payroll Tax Plan

President Trump pushes to cut Social Security payroll taxes for the rest of 2020. Yahoo Finance’s Brian Cheung shares the details.

Video Transcript

ADAM SHAPIRO: It's time for Yahoo U, and President Donald Trump signed an executive order last week in enacting a payroll tax cut for Americans. So what should workers expect to see on their pay stubs? And will it really help jolt the US economy? Yahoo Finance's Brian Cheung is here to explain in this week's Yahoo U. And you never get tongue-tied, do you?

BRIAN CHEUNG: Not at all, Adam. Well, class is in session. And it's been said before that what goes around, comes back around. And that certainly applies to even boring things like the payroll tax cut. So let's unpack obviously all of this based on the executive order that President Trump put into effect over the weekend.

And the order is really going along these guidelines here. So it's targeting specifically the social security tax, which comes out of every American's paycheck. And the tax holiday is effective for the period September 1 through December 31, the end of the year. So you'll really start to see these effects beginning in a few weeks.

Now, notably, this is not going to cover every American. It's only going to cover those that are making less than $104,000 per year. So if you make more than, say, $4,000 biweekly, you're not going to be affected by this change. So here's an example pay stub, and when your employer pays you, they'll detail your gross salary. And you should be familiar with what this looks like on your paycheck.

At the federal level, Americans will pay these types of taxes, right? A federal withholding, social security, federal Medicare. So the executive order that President Trump put into effect over the weekend really targets this one here, social security. Now, the most important thing is that if this disappears over that period through the end of the year, it's going to be temporary.

The taxes saved through December will eventually have to be paid back at some point because this is a temporary deferral. That is, unless President Trump wins re-election. That's because he said when he announced this over the weekend, quote, "after the election, on the assumption that it would be victorious for an administration that's done a great job, we will be ending that tax. We will be terminating that tax."

So basically, there's no promise you won't eventually have to pay back the savings from this tax holiday. Now, we've seen this movie played out before if it is indeed temporary. If we rewind to 1992, President George H.W. Bush passed a very similar tax holiday. He also got around Congress by signing an executive order. This time, though, it's targeting the withholding tax change whereas the Trump changes targeting against social security.

But the premise is still basically the same. It's to stimulate the economy. And at the time, President Bush said, "something tells me a number of taxpayers may take us up on this one." Now, the question is, did it really? If you look at a University of Michigan survey from a month afterwards in 1992, the answer is really meh.

So about 41% said they would use the money to spend. That's exactly what the government would want to do in this case. But another, let's say, less than half, about 44%, said they really plan to save it or pay down debt. So many even filed with the IRS to say, you know what, don't even change the withholding. I don't want it.

And this is what they have-- this is what they've called the economic concept of Ricardian equivalence, the idea of not changing demand because of the expectation that, well, it's temporary, right? Uncle Sam is just going to come knocking later and ask for the money back. Now, later in the summer, the Congressional Budget Office confirmed this effect. It said the effect of the Bush tax cut was really only about half as powerful as originally estimated because people didn't go back into the economy and spend all of it.

So let's apply what we learned from 1992 to the expectation for the 2020 tax cut put in place by President Trump here. Goldman Sachs estimates that if the government were collecting that Social Security tax through the end of the year, it would be about $275 billion. That's a pretty substantial amount of money. But again, if 1992 is a model, the real effect of that might only be about half.

Now, this right here isn't even the biggest criticism. This is. This is the number of unemployed Americans through this COVID crisis. And the latest number was 16.3 million Americans as of July. This is the amount of people that are out of work. And these are people that have no paychecks at all.

So if this is a payroll tax deferral, this is going to have no impact on all these people that don't have jobs, which really emphasizes the need for other types of fiscal support to target this demographic. That would be extended unemployment insurance, for example, supporting businesses, which are really their employers. Those are things that are really been helpful to the, well, not necessarily, a payroll tax cut.

So in summary, the key thing here is really that this isn't a tax cut. This is really a tax deferral. So it's important to not only look at your pay stubs through the end of this year, but also look at your pay stubs at the beginning of next year where you might have to be paying back all those taxes and social security that you didn't pay through the end of this year. So as I mentioned, what goes around does eventually come back around. Adam, Julie.