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.

A. Analysis. This part of the assignment asks you to describe and discuss the likely effects of this policy in different areas. Please answer all parts. In your answers, you should indicate what additional information would help you answer this question. Assume that, other than the payroll tax, all labor markets are free and competitive.

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clearly mark the youth take-home wage (after-tax wage) when there is a tax as Wt and the wage after the tax has been repealed as Wo.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. Then answer: 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.

2. Implication for the Social Security Program. Social Security tax payments have flowed into a Federal trust fund for many years. Currently, annual benefit payments to retirees exceed annual payroll tax revenues, so the trust fund is being depleted, and will be exhausted in about 15 years. At that time and thereafter, unless other policy actions are taken, annual benefits payments to retirees must be cut below promised benefits so that benefits paid match payroll tax revenues received each year.

a. 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?

b. 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.