Reihan Salam suggests payroll tax reform for younger workers

My ideal approach, however, would involve reforming Social Security and the Social Security payroll tax along the lines Edward Prescott proposed several years ago. Basically, the system would become a defined contribution system. Between 18 and 35, contributions would steadily increase, thus facilitating consumption smoothing.

Doing something along these lines could have important incentive effects. The issue is complex and depends a lot on how people make long term decisions. However, my best guess is that lowering payroll taxes on younger workers would encourage labor supply. For younger people I think the intuition about income and substitution effects goes the other way.

That is higher wages will make kids work more, not less.

Perhaps just as importantly during an economic downturn is temporarily lowering the payroll tax paid by the employer. As far as I can tell this is the one of the least popular options out there but it makes a lot of sense to me.

Whether you think hiring is low because of cash flow constraints, intertermporal choice issues, low worker marginal product or uncertainty this policy should increase hiring. It means that workers today are relatively cheap compared to workers tomorrow. Thus if you were ever going to hire someone, now is the time.

Moreover, for employers who don’t really want to trim payrolls because of human and organizational capital loss, this policy gives them the means to hang on to workers.

That’s just a shameless plug for my favorite anti-recession policy.

The other thing I wanted to point out though is defined contribution plans have the danger of being off balance sheet obligations for the government.

It may sound as if a defined contribution plan means that you get out what you put in, plus return on investment. That will hold in normal times. However, suppose that there is a massive and sustained stock market crash.

Or, more likely suppose that the growth of private equity drives down the return for retail investors so low that few can retire in the manner they hoped. Is it likely that the government will stand by and do nothing in the face of this? Can the government credibly commit to massively disappoint older upper middle class voters?

That seems unlikely to me. If defined contribution plans fall short of their mark the government is on the hook one way or the other. It might be stealth, like forgiving all taxes associated with 401(k)s even when the money is taken out. Or allowing refundable housing credits for seniors or something like that.

However, it seems likely that if defined contribution goes to pot, the government will step in and do something.