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Monday, November 15, 2010

Social Security: If The Rich Paid Taxes Like You And Me…Problem Solved

Over the course of the past couple of weeks we’ve been talking about how the War On Social Security was about to get under way and what happens when countries choose to privatize their systems.

Today we take on another bite-sized chunk of economic analysis: how can you get to a situation where Social Security is financially stable for the next 75 years?

We’ll describe some proposals that are out there—but the big focus of this conversation will be to look at one change that, all by itself, could not only solve the entire funding problem, but could actually allow us to lower the Social Security tax rate, immediately, and still achieve fiscal balance.

“Well, if that’s such a bright idea” you might ask, “why haven’t we adopted it already?”

That’s a great question—and after you hear the proposal, you may well have explanations of your own.

The possibility of victory can be a heavy millstone around the neck of any political candidate who might prefer, in his heart, to spend his main energies on a series of terrifying, whiplash assaults on everything the voters hold dear. There are harsh echoes of the Magic Christian in this technique: The candidate first creates an impossible psychic maze, then he drags the voters into it and flails them constantly with gibberish and rude shocks…

--From the Rolling Stone magazine article Freak Power in the Rockies: The Battle of Aspen, by Hunter S. Thompson

It was just this week that the Presidential Debt Commission (officially the National Commission on Fiscal Responsibility and Reform) “pre-released” some proposals for how they would resolve the various fiscal problems our country is facing these days, and among those were recommendations that the Social Security retirement age eventually be raised to 69 and that the amount paid in Social Security benefits should no longer increase as fast as inflation; both proposals, ultimately, represent cutting your benefits.

Far too many people are instinctively OK with these ideas because they assume they’ll never see a single dollar of the Social Security benefits they were promised anyway…which means far too many people believe in a giant urban legend.

Here’s the reality: no matter what, even if no financing changes are made, Social Security can pay 100% of anticipated benefits out through 2037. Even after that, if no changes are made, enough money will still be coming in to pay about 75% of anticipated benefits for roughly 50 more years after 2037. (We can’t speak to what will happen after that because the Social Security actuaries only look 75 years into the future when they make estimates.)

Here’s another reality: the total amount of wages that are subject to Social Security tax (also known as the “wage pool”) does not equal 100% of the total amount of wages paid to workers in the United States. That’s because income above a certain amount (at the moment, $106,800) is exempt from Social Security taxes.

During the 1980s and early 1990s, the wage pool represented about 90% of all wages…but because wage income has become more and more concentrated in the hands of the highest wage earners, 15 years later the wage pool now represents only about 83% of all wages.

In fact:

…due to high levels of earnings inequality, roughly 1% of the population earn 10% of all the earnings.

We know all this because of the fine work of Debra B. Whitman and Janemarie Mulvarney, both of the Congressional Research Service (CRS), who prepared the CRS report "Social Security: Raising or Eliminating the Taxable Earnings Base", released in September of 2010. (Unless you see a link associated with a particular fact, from here on out what you’re reading is based on their work.)

So if we’re looking to achieve stability in Social Security financing, the question really becomes: how do we get back to a point where the size of the wage pool remains at least stable, or even grows larger over time?

In the 1980s, facing the same problem, the Reagan Administration negotiated an increase in the tax rate for taxable income, causing the wage pool to grow to that 90% number we talked about earlier…but today, we’re going to look in a different direction.

And that’s because, as it turns out, removing that $106,800 cap and making all wage income taxable for Social Security purposes, all by itself, will either solve the funding problem entirely or get you to 99% of where you need to be, depending on the choices you make.

Here’s how it works out:

Today, the amount of Social Security benefits you’ll collect depends on how much you pay into the system; the current maximum benefit is $2346.

What you could do is “break the link” between “paid in” and “paid out” by establishing a maximum benefit, no matter how much you pay in. If you kept the maximum where it is today, and that amount rose to equal inflation over time, the CRS tells us we would actually have 115% of the money we need to get to Social Security fiscal stability. As a result, we could afford to lower the payroll tax rate by .3% and we’d still be at fiscal stability.

Those who oppose this approach will tell you it will create political trouble for Social Security going forward because Americans will no longer see it as an investment program, but instead as a “welfare” program, which is presumably more politically vulnerable.

I would disagree, for a few reasons: for one, there’s the fact that Social Security is not, and has never been, an “investment” program, for another, not many people actually make more than the maximum, anyway (94% of workers earned less than the maximum in 2007). Beyond that, those that do make more than the maximum tend to be, shall we say, geographically concentrated, mostly in the suburbs of New York City and Washington, DC:

…focusing on the nationwide average hides the diversity among the states and the District of Columbia. The share of the population above the base ranges from a high in New Jersey where nearly 12% of covered workers earn above the base, to a low in South Dakota, where 2% of workers earn above this amount…

There’s another reason this kind of change wouldn’t be as politically problematic as some might think:

CRS estimated the potential impact of eliminating the taxable wage base on future benefits and taxes. If the base were removed in 2013, CRS estimates that by 2035, 21% of beneficiaries would have paid some additional payroll taxes over the course of their lifetimes. However, the average change in taxes and benefits would be small. Looking only at individuals who would pay any additional taxes over the course of their lifetimes, at the median, total lifetime tax payments would rise by 3% and benefits would increase by 2% relative to current law. In general, those in the highest income groups would have the largest changes in both tax payments and in benefits relative to current law.

(Emphasis is original)

You should also know that, in the 1990s, the income cap on the Medicare portion of payroll tax collections was lifted; this does not seem to have caused great damage to that program, politically speaking.

So the other way this change could be made would be to continue to base maximum benefits on what’s paid in, and still remove the cap on taxable earnings.

The Social Security Administration estimates that such an approach would raise 95% of the amount you need to achieve Social Security fiscal stability, so you’d still need to raise a bit of money, but you would be awfully close to fiscally stable, and far better off, financially, then we are today. (A payroll tax rate increase of .1% could raise the amount needed.)

That said, I think this approach actually creates more political vulnerability for the Social Security “concept” than uncapping taxes while capping benefits, and here’s why:

If you cap benefits, you immediately get to reduce the tax rate for everyone, which is going to be very popular; an unlimited benefit still requires you to raise taxes, even after the tax cap is lifted. One of those choices is going to be a lot better received than the other, I’m thinking, especially as “no new taxes” is such a popular political mantra these days.

However, it’s also true that a substantial number of beneficiaries would see benefit increases, even if the vast majority of those folks wouldn’t actually benefit all that much:

CRS estimates that 23% of beneficiaries in 2035 would have higher benefits than under current law. This share of beneficiaries who receive higher benefits is greater than the share of individuals who pay higher taxes because some low earners receive benefits based on their spouses’ higher earnings. Most of the affected beneficiaries (20%) would see their benefits increase by less than 10% relative to current law. Only 3% of beneficiaries would see their benefits increase by 10% or more.

But if you ask me (and if you’ve read this far, you are asking me) the real political problem from an approach that allows for unlimited benefits, is that it allows for…unlimited benefits:

Annual Social Security benefit payments would be much higher than today’s maximum of $25,440. A worker who paid taxes on earnings of $400,000 each year would get a benefit of approximately $6,000 a month or $72,000 a year…while someone with lifetime earnings of $1 million a year would get a monthly Social Security benefit of approximately $13,500 a month or $162,000 a year…

Imagine, if you will, just how easy it would be to launch a political attack on a government program that pays $162,000 a year to rich people…and if you can imagine that, you can probably imagine just how much political trouble this approach could cause.

Both options, just for the sake of the discussion, raise the wage base from today’s 83% to about 92%; a 2008 estimate suggested this would raise an additional $680 billion over 10 years. (An intermediate option, raising the tax cap to something like $190,000 of wage income, would have raised about $600 billion over the same period.)

So there you go: removing the cap on how much of your earnings are taxed for Social Security purposes, all by itself, could not only solve the funding problem faced by the system going forward, but you could even lower taxes slightly while doing it; another variation of the same approach would get you to 95% of where you need to be, but would still require a tax increase to get us to fiscal balance.

One approach keeps a lid on maximum benefits, the other doesn’t; in my opinion, the plan that keeps a cap on benefits is the one with less political peril going forward.

Either way, there would be no need to “adjust the inflation index downward”, which is a fancy way of saying “we’re cutting your benefits”, and you wouldn’t have to change the retirement age, either, which is a less fancy way of saying “we’re cutting your benefits”; both are among the Debt Commission’s “pre-release” proposals.

So what do you think, America? Given the choice, would you prefer that Social Security benefits be cut, now and in the future, or would you prefer to see the wealthiest among us pay their fair share of Social Security taxes, just as every other wage earner does—and cut the tax rate, both at the same time?

This would be exactly the time to make your feelings about that choice known, and if I were you I’d be on the phone to my member of Congress now, today—and when January comes around, and a new Congress begins…I’d be on the phone again.

It’s your Social Security, and if you want it funded in a more rational way this would be the time to say so…and if you’re reaching for the phone right about now, I’ve done my job.

FULL DISCLOSURE: This post was written with the support of the CAF State Blogger's Network Project.

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