Posted on September 13, 2020
Well, I feel like we’ve been here before. After employers were allowed back in late March to start deferring payment of their share of the Social Security payroll tax, now employees are allowed to do the same–though it will largely be employers who make the decision. The President’s executive action of August 8, allowing the employee tax deferral, kicked in on September 1, although in practice the start is delayed because the IRS guidance wasn’t released until August 28. Like the employer payroll tax deferral, the employee tax deferral lasts until the end of the calendar year. The employee tax deferred amounts must be paid back, in the form of increased withholding amounts, evenly from paychecks over the first four months of 2021; the employer-side deferred amounts don’t need to be paid back until the end of 2021 (half of the amount) and 2022 (the other half).
Estimates of federal revenue effects of legislative tax changes, or in this case executive actions, are most accurate when take-up rates aren’t involved–that is, when everyone is mandated to do something. With this executive order, the take-up rate–the proportion of employers who elect to undertake the deferral for their employees–will be critical for the effect on withholding, which we use to estimate withholding changes on a constant law basis so as to line up changes in withholding with wages and salaries.
The take-up rate for the employer-side payroll tax deferral from earlier in the year appears to have been quite anemic, and the current chatter is that we will also see anemic take-up of the employee payroll tax deferral. In our assessment of the take-up of the employer payroll taxes, from looking at financial statements, it appeared that large, public companies who elected to defer accounted for maybe 20 percent to 25 percent of national employment. When factoring in smaller employers who were less likely to defer, the percentage of total economy-wide employment was probably a bit lower.
Based on what we gather from payroll and other experts, we’re currently estimating that the executive action will reduce withholding by about 1.7 percent, not a large amount considering that employee-side payroll taxes make-up about 17.5 percent of total withholding tax receipts. For our estimates of withholding on a constant law basis, we’ll be adjusting the observed growth in withholding, which will include any deferrals, by that 1.7 percentage points, phased in over a period of weeks as employers make their decisions. Our estimate of 1.7 percent is based on the multiplication of three components (bolded below):
- We assume that the take-up of the payroll tax deferral will cover about 12.25 percent of qualifying employees. That is itself the combination of two components: a 10 percent assumed take-up in the non-federal-government sector; and a 2.5 percent effect from both civilian and military (but not postal) being covered, as the non-postal executive branch of the federal government, which accounts for roughly 98 percent of all non-postal federal employment, has announced that it is adopting the deferral. We estimate that the federal government sector accounts for about 2.5 percent of national employment and that the wage share and payroll tax share is about the same. (The 12.25 percent is not quite the sum of the 10 percent and the 2.5 percent because there is an interaction.) The assumed private sector take-up rate (10 percent) is so small in part because employers appear to be on the hook for paying back the deferred amounts in 2021 if the employee leaves work abruptly. In that case, the employer would be unable to take the deferred amounts out of the worker’s paychecks in the first four months of 2021 as stipulated in the IRS guidance, or even all of the remaining deferred amount in the last paycheck if the worker leaves very abruptly. Also, payroll processing costs of implementing the deferral, when a lot of employees don’t even want the deferral, should be a factor. Also, most employers didn’t adopt the deferral for their own half of the Social Security tax earlier in the year when the deferral covered a much longer period.
- We estimate that about 80 percent of relevant wages earned are potentially covered by the executive action if all employers opted-in for their workers. The executive action stipulated that only workers earning less than $4,000 on a bi-weekly basis (or the equivalent for other payment schedules, so about $104,000 in annual pay) qualify for the deferral. We used information on the wage distribution from W-2s for 2018 provided by the Social Security Administration to get that 80 percent figure–basically the amount of wages for workers earned below $104,000 annually as a percentage of wages earned by workers up to the current Social Security tax base, which is limited to earnings below $137,700 for a worker in 2020.
- We calculate from the Treasury Department’s Monthly Treasury Statement that in a normal year about 35 percent of total withholding revenues (from income taxes, Social Security taxes, and Medicare taxes) is from the Social Security tax, and about half of that (17.5 percent) is from the employee-side tax. So, if all workers and earnings were covered by the employee payroll tax deferral, withholding growth would drop by about 17.5 percent.
We should be able to monitor large employers to see what they are doing and adjust our estimate of 1.7 percent if necessary. It won’t be a state secret which firms are adopting the change for their employees because the workers can just look at their pay stubs. Richard Rubin of the Wall Street Journal has been doing a nice job of tracking whether employers are planning to defer the employee payroll tax or not. (Sorry, a subscription to the Journal is needed so I can’t link to his latest article.) So far large employers either seem to be electing not to defer or are still studying the issue, although Rubin’s sample is currently very small. In theory firms could allow employees to choose, but the costs of implementing that system could be prohibitive for many employers.
We have already been adjusting withholding growth by 4 percentage points to reflect the effects of legislation enacted in March, and our adjustment will now be (with a phase-in) about 5.7 percentage points. Because those law changes have all reduced withholding growth, we will take observed growth (which includes the effects of the law changes that have reduced withholding growth) and add 5.7 percentage points to measure growth on a constant law basis. Since we developed the estimate of 4 percentage points for the March legislation (see post of June 8), we have learned that the effects of the employer Social Security tax deferral have probably been a bit larger than we expected but the effects of the payroll tax credits for employee retention and sick and family leave have probably been a bit smaller. We infer that the 4 percentage point adjustment has been reasonably close to what has actually occurred because our measure of withholding growth adjusted for law changes has been lining up relatively closely with wage growth as measured in the monthly employment reports by the Bureau of Labor Statistics (see post of September 5). The introduction of law changes and executive actions that affect withholding do add uncertainty to our constant law measure of withholding growth.