Public Policy

The government is concerned about low employment rates and low earnings of young persons under the age of 25, including those who are no longer in school. It wants to help younger persons get started in the labor market. The government is considering a Social Security payroll tax cut for younger workers. This payroll tax is used to finance Social Security income benefits for retirees. The payroll tax is assessed equally on employers and employees: 6.2% each for a total of 12.4% on the first $133,000 of earnings. (For simplicity, treat the payroll tax as a unit tax on labor.) The proposal would eliminate this tax until age 25. Young workers would continue to accumulate eligibility for retirement benefits as if they and their employers were making payroll tax payments on their earnings.

1. Impact on the youth labor market (under age 25): Use a supply and demand diagram of the labor market for youth to illustrate the impact of the repeal of the payroll tax on the take-home wage of young workers and the youth employment level. In your diagram, clearly mark the youth take-home wage (after-tax wage) when there is a tax as Wt and the wage after the tax has been repealed as Wo. Mark the youth employment levels corresponding to these wages as Et and Eo.
2. Who wins and who loses in this labor market from the repeal of this tax? What determines how much the winners win and the losers lose. Try to be specific.
3. Implications for social security program: Assuming the government takes no other action, what is the likely effect of suspending the payroll tax for youth on the Social Security program? Who is likely to be most affected?
4. Advocates of the youth payroll tax cut argue that, in the long run, the cut would improve the financial viability of the Social Security program. Is that possible? Explain your answer.