Governor Andrew Cuomo (D) of New York continues to explore various options to ensure that higher-income New York residents are not burdened by the new federal cap on the state and local taxes (SALT) paid deduction. On Thursday, the Cuomo Administration plans to release two policy proposals. The first would create a charitable contribution option for New York residents, where individuals can “donate” their taxes directly to education or health-related programs. We’ve written on multiple occasions on why such plans likely won’t survive Internal Revenue Service (IRS) scrutiny. The second proposal would create an optional employer-side payroll taxA payroll tax is a tax paid on the wages and salaries of employees to finance social insurance programs like Social Security, Medicare, and unemployment insurance. Payroll taxes are social insurance taxes that comprise 24.8 percent of combined federal, state, and local government revenue, the second largest source of that combined tax revenue. in New York. Creating a new payroll taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. has a number of policy and legal challenges. In particular, if adopted, this proposal could lower lifetime Social Security benefits for New Yorkers.
Under an initial statement released Monday, New York employers “would be subject to a five percent tax on all annual payroll expenses in excess of $40,000 per employee” if they choose to participate. The plan would phase in over three years. Individuals would receive an offsetting individual income tax credit, to ensure that the plan is revenue-neutral for the state.
The proposal is designed to take advantage of the uncapped SALT deduction for businesses. Under the Tax Cuts and Jobs Act, businesses can still deduct all of their state and local taxes paid, while individuals would be limited to a $10,000 annual cap.
This plan would raise costs on employers. They’d bear the full cost of the employee’s salary and then be subject to an additional 5 percent payroll tax. Proponents of this approach acknowledge that employee “wage[s] would have to drop by the amount of the new payroll tax” to ensure that employers do not have a higher burden. There are obvious concerns due to wage stickiness. It would be difficult for an employer to lower an employee’s wage in response to the new tax. In some cases, such as union employees under a labor contract, it could be almost impossible in the short term.
Although the Cuomo Administration has made some moves to suggest that they’re considering the unintended consequences, there is no indication the governor’s proposal could avoid impacting an individual’s eligibility for federal benefits under Social Security.
Social Security benefits are determined in large part by the employee’s taxable wages during their income-earning years. The Social Security Administration averages the amount earned, after adjusting for inflation, in your 35 highest-earning years. Your “average indexed monthly earnings” are then adjusted based on other factors, such as when you start calculating benefits and how you receive them impacts your benefits received calculation as well. Benefits are reduced, for instance, if an individual decides to accept them early, before their full retirement age.
But that means if an employee receives less in wages than they otherwise would have due to this payroll tax program, their Social Security benefits in retirement would be less.
This reduction would also be regressive. For high-income individuals, Social Security benefits do not grow when incomes exceed a specific level. In 2018, that is $128,400. But for an individual below the contribution and benefit base limit, limiting wages would have a larger impact. It would reduce the wage base that determines their benefits.
Finally, this also has the impact of lowering Social Security payroll tax revenues. By lowering the taxable wage base, the federal government will collect less in revenue, putting a strain on the Social Security Administration’s ability to pay benefits for current beneficiaries. This is also true of federal revenues in general. By increasing the SALT deductions taken by businesses, while reducing income for individuals, the federal government’s tax base is being eroded.
These workaround proposals are highly questionable policy to begin with. Lawmakers pushing these ideas have stated their concerns with the progressivity of the tax code, yet they’re advocating for extremely complex laws that would help higher-income taxpayers save money. Even in the event that the IRS were to bless the payroll tax idea, New York would then have to contend with the harm it could do to future Social Security benefits.
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