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Trump's federal tax deferral debacle a reminder that good tax policy matters

Hopefully we can use this boondoggle to learn what not to do in the future — and maybe even look for ways to modernize our tax system going forward.
Image: Donald Trump
Trump's deferral executive order backfired -- just as experts thought it might.Evan Vucci / AP

Some former Trump administration appointees now no longer employed by the government recently were surprised by tax bills from their former employer associated with payroll taxes from last year. Former President Donald Trump seemed to genuinely believe he was going to put extra money in people’s pockets. Instead, he highlighted the differences in good and bad tax policy — differences that can have pricey consequences.

The executive order did not and could not eliminate the tax, it only deferred it. Generally only Congress has the power to impose or remove taxes.

Last August, in the middle of the Covid-19 crisis, Trump issued an executive order — against the advice of tax experts from the right and the left — directing the secretary of the Treasury to allow all employers to defer withholding on the employee share of social security taxes for employees making less than $4,000 in a biweekly pay period.

What did this mean? It meant that an employer could choose to not withhold the 6.2 percent employee share of taxes due for around nine biweekly pay periods, from September 2020 to this January. That’s a potential total deferral of over $2,000 in payroll taxes.

The catch? The executive order did not and could not eliminate the tax, it only deferred it. Generally only Congress has the power to impose or remove taxes.

After the executive order, the IRS issued guidance allowing employers to withhold those dollars in the first four months of 2021. But Congress and Trump — in December 2020 — enacted into law a provision allowing employers to withhold those dollars over the entirety of 2021. This means federal employees will have to pay extra each paycheck, but spread out over the year.

For the most part, perhaps on the advice of their own in-house experts, large employers mostly rejected Trump's opportunity. This makes sense for several reasons, including the fact that the employer is responsible for ensuring those taxes are withheld in 2021. If an employee retired after the taxes were withheld, the employer may have a hard time getting those dollars back. Additionally, it can be costly (not to mention an administrative headache) for large companies to change their accounting systems for a short period of time.

Unfortunately for government employees, the government, including the military, did take Trump up on his idea in 2020. And Trump political appointees — many of whom no longer work for the federal government — don’t have the option of paying the money back incrementally. For these former federal employees, they must pay a lump sum.

A surprise change in your paycheck — or a large IRS bill come tax time — is never a pleasant surprise. Trump’s executive order, though presumably well meaning, ultimately did real harm to the expectations of many government workers and their budgets. But it’s also instructive. Tax policy isn’t sexy, but it remains vitally — if dryly — important.

First, Social Security is popular because the idea of a retirement safety net gives workers a sense of societal security. But it is popular, too, because of the way it is withheld.

It turns out that paying taxes in small sums over a period of time provides a better experience for most taxpayers. We don’t feel like the cost is as high when it is slowly pulled out of our paychecks instead of coming due in one lump sum.

Some tax experts in fact have called for state governments to adopt these principles for property taxes. The argument goes that if municipal authorities were to have real estate taxes withheld monthly, as banks do for people with mortgages, people would have an easier time making those payments and the government would be more ensured of receiving tax dollars due.

No one enjoys paying taxes, but the experience can be better or worse depending on how we design them. The primary lesson here is that badly designed tax policy can do real harm to the lives of citizens. The good news is it’s possible to do better.

With Tax Day just behind us, one possibility ought get more traction: a ready return. The ready return was a pilot program in California in 2004 with a free pre-filled state tax return based on a taxpayers W-2 and previous years filings. It saved taxpayers time and money and was less error prone than other methods of preparation. Californians mostly liked it and California adopted it, in part, into its CalFile System, but it never caught on widely.

This is good tax design that makes people’s lives easier. For most people there is almost no reason to have to file an income tax return every year. The government knows everything it needs to know to get your taxes right.

The GOP and Trump intuitively supported this idea in 2017 when they proposed being able to file a tax return on a postcard. Though the tax return on a postcard did not fly, the idea behind it, making tax paying simpler, is a good one, and is within our reach.

So, though I am sorry many government employees experienced a tightened budget at the beginning of 2021, hopefully we can learn what not to do in the future — and maybe even look for ways to modernize our tax system going forward.