Payroll Taxes in the Finance of Social Security

The growing use of payroll taxes to finance social security has raised concerns about their potential effects on employment. This analysis reviews evidence about the economic attributes of payroll taxes and compares them with alternate means of finance. First, the comparative attributes of general payroll taxes unattached to benefit programs are examined, and their long-run performance in economic efficiency and growth are found to be relatively favourable. Second, the reasons for using payroll taxes to finance social security programs in particular are assessed. The nature of benefit-tax linkages and the associated incentive effects are explored. Third, evidence on the long-run incidence of employer payroll taxes and their employment effects is assessed. It is found that most or all of the short-run employment effects dissipate in the longer run, as the tax burden is shifted into lower pay. Policy findings are that payroll taxes are well suited for financing social security, benefit-tax linkages may need reform in some programs from both the benefit and tax sides, and the transitory employment effects of changes in payroll tax rates should not dominate longer-run considerations for public policy.