The Federal Reserve Board’s Eight Percentage Point Hike in the Social Security Tax

November 30, 2015

Dean Baker
Truthout, November 30, 2015

View article at original source.

In the last couple of weeks the prospect of a 0.2 percentage point increase in the payroll tax has become a major issue separating the two leading contenders for the Democratic presidential nomination. Senator Bernie Sanders has proposed an increase of this size to pay for system of paid family leave that is part of his platform. While former Secretary of State Hillary Clinton also supports paid family leave, she opposes any tax increase on middle class workers, and insists she can get the money elsewhere.

The intensity of this debate over a tax increase of 0.2 percentage points (@ $70 a year for a typical worker), should have people wondering why the candidates aren’t talking about the prospect of a much larger tax increase imposed by the Federal Reserve Board. The Fed’s tax increase could easily exceed 8 percent of the wages for ordinary workers, yet it is not drawing any attention from the presidential candidates.

The idea of the Fed imposing a tax on workers may sound a bit strange. The Fed doesn’t literally make deductions from workers’ paychecks, like Social Security and Medicare. Rather, the Fed’s actions affect what goes into workers’ paychecks. By making the labor market tighter or looser, the Fed affects workers’ ability to get wage gains or to even keep their pay rising in step with prices.

On average, workers’ pay had kept pace with productivity growth in the economy until the recession in 2008. Not all workers saw these gains, since the benefits of productivity were highly skewed towards those at the top, like doctors, CEOs, and Wall Street bankers. But the share of workers as a whole changed little from the late 1970s to 2007.

When the collapse of the housing bubble sank the economy and sent the unemployment rate soaring, workers’ share of national income plummeted. Prior to the collapse, workers’ share of the income generated in the corporate sector had averaged close to 82 percent. This fell as low as 73 percent in the downturn. It has since edged up slightly, but it is still be below 75 percent.

This means that wages are more than 8.0 percent lower on average than would be the case if the collapse of the housing bubble had not devastated the labor market. From the standpoint of workers’ ability to pay for their food, rent, and other bills it makes no difference whether the government taxes away another 8 percent of their pay or whether the Fed’s policies push down their pay by 8 percent. Either way, they have 8 percent less money.

Of course, the Fed did not deliberately bring on the collapse of the housing bubble and the resulting recession. However, we faced this crisis because of the Fed’s failure to recognize the growth of the housing bubble and to take steps to counter it. The Fed had substantial regulatory power which could have been used to check the explosion of bad mortgages that fueled the bubble. It also has an enormous platform which could have been used to warn investors and homebuyers of the risks of the bubble.

The Fed’s failure to recognize and take steps to contain the housing bubble was one of the largest policy blunders of the last century, but the question at the moment is its policy going forward. Here there is real ground for concern that it seems intent on preventing workers from regaining the wages they lost in the downturn.

The Fed has indicated its intention to raise interest rates in order to slow the economy and reduce the rate at which the economy is generating jobs. This will prevent the labor market from getting tighter.

There is no guarantee that the labor market would get tight enough to allow workers to regain the ground they lost even if the Fed didn’t act to slow growth. The growth rate has been weak throughout the recovery. The U.S. economy currently faces drag from weak foreign economies and the downside risk of collapsing bubbles in some commercial and residential real markets, as well as some tech stocks. While these bubbles are not large enough that their collapse will bring on a recession, it will slow growth further.

For these reasons, leaving rates low doesn’t guarantee that workers regain the ground they lost in the downturn, but if the Fed raises rates fast enough, it will certainly guarantee that the wages do not return to their pre-recession share of income. This policy is especially pernicious, since it tends to be workers at the middle and bottom of the pay ladder who benefit most from a tight labor market, which means that the workers most in need of help will be penalized by the Fed’ rate hikes.

In short, it’s interesting to watch the presidential candidates fighting over a 0.2 percentage point tax increase. It would be much more interesting to see them debate a Federal Reserve Board policy that can have an impact on after-tax pay that is 40 times larger.

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